As filed with the Securities and Exchange Commission on October 4, 2004
Registration No. 333-115589
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
COGENT COMMUNICATIONS GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware (State or Other Jurisdiction of Incorporation or Organization) |
4813 (Primary Standard Industrial Classification Number) |
52-2337274 (IRS Employer Identification No.) |
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1015 31st Street N.W. Washington, D.C. 20007 Tel: (202) 295-4200 (Address, including zip code, and telephone number, including area code, of Registrant's principal executive offices) |
Dave Schaeffer Chief Executive Officer Cogent Communications Group, Inc. 1015 31st Street N.W. Washington, D.C. 20007 Tel: (202) 295-4200 (Name, address, including zip code, and telephone number, including area code, of agent for service) |
Copies to: |
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David M. McPherson, Esq. Latham & Watkins LLP 555 Eleventh Street, N.W. Washington, D.C. 20004 (202) 637-2200 |
James J. Junewicz, Esq. Mayer, Brown, Rowe & Maw LLP 190 South LaSalle St., 3900 Chicago, IL 60603 (312) 701-7032 |
Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. o
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If the delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. o
CALCULATION OF REGISTRATION FEE
Title of each Class of Securities to be Registered |
Proposed Maximum Aggregate Offering Price(a)(b) |
Amount of Registration Fee |
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Common stock, $0.001 par value | $57,500,000 | $7,286(c) | ||
The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
This registration statement contains two front and back cover pages for the prospectus, the first of which will be used in connection with the underwritten public offering of up to shares of common stock pursuant to this registration statement, and the second of which will be used in connection with the offering by the registrant directly to certain of its existing stockholders of up to shares of common stock pursuant to this registration statement. After this registration statement becomes effective, all prospectuses distributed to the public will bear the first forms of front and back cover pages, and the prospectus distributed to such existing stockholders will bear the second forms of front and back cover pages.
The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any state where the offer or sale is not permitted.
PROSPECTUS
(Subject to Completion, dated , 2004)
Shares of Common Stock
Cogent Communications Group, Inc.
We are offering shares of our common stock to the public.
Immediately prior to this offering, we will implement a 1-for-20 reverse stock split and all of our outstanding shares of preferred stock will be converted into shares of our common stock. Our common stock is traded on the American Stock Exchange under the symbol "COI." The last reported sale price of our common stock on October 1, 2004 was $0.32 per share.
We have granted the underwriters the right to purchase up to an additional shares to cover over-allotments.
Concurrently with the offering to the public, we also are offering, at the public offering price, an aggregate of shares of our common stock to certain of our existing stockholders. We refer to these entities as the participating stockholders. These entities have indicated an interest in purchasing an aggregate of shares of our common stock. The consummation of the offering to the public will be conditioned on the consummation of the offering to the participating stockholders. In this prospectus, we refer to the offering to the public and to the participating stockholders together as "this offering." The shares to be offered to the participating stockholders represent approximately 20% of the total number of shares in this offering (assuming no exercise of the underwriters' over-allotment option).
Investing in our common stock involves risks. See "Risk Factors" beginning on page 7.
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Per Share |
Total |
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Price to the public | $ | $ | ||||
Underwriting discounts | ||||||
Proceeds to us (before expenses) |
The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
The underwriters expect to deliver the shares to purchasers on , 2004.
Jefferies & Company, Inc. | ||
CIBC World Markets |
Friedman Billings Ramsey |
The date of this prospectus is , 2004
The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any state where the offer or sale is not permitted.
PROSPECTUS
(Subject to Completion, dated , 2004)
Shares of Common Stock
Cogent Communications Group, Inc.
We are offering shares of our common stock to certain of our existing stockholders. We refer to these entities as the participating stockholders.
Immediately prior to this offering, we will implement a 1-for-20 reverse stock split and all of our outstanding shares of preferred stock will be converted into shares of our common stock. Our common stock is traded on the American Stock Exchange under the symbol "COI." The last reported sale price of our common stock on October 1, 2004 was $0.32 per share.
Concurrently with the offering to the participating stockholders, we are also offering, at the price to the participating stockholders, shares of common stock to the public through underwriters. The consummation of the offering to the participating stockholders will be conditioned on the consummation of the offering to the public. In this prospectus, we refer to the offering to the participating stockholders and to the public together as "this offering."
Investing in our common stock involves risks. See "Risk Factors" beginning on page 7.
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Per Share |
Total |
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Price to the participating stockholders | $ | $ | ||||
Proceeds to us (before expenses) |
The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
We expect to deliver the shares to the participating stockholders on , 2004.
The date of this prospectus is , 2004
You should rely only on the information contained in this prospectus. We and the underwriters have not authorized anyone to provide you with different or additional information. This prospectus is not an offer to sell or a solicitation of an offer to buy our common stock in any jurisdiction where it is unlawful to do so. The information contained in this prospectus is accurate only as of its date, regardless of the date of delivery of this prospectus or of any sale of our common stock.
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Prospectus Summary | 1 | |
Risk Factors | 7 | |
Special Note Regarding Forward-Looking Statements | 19 | |
Special Note Regarding Arthur Andersen LLP | 19 | |
Use of Proceeds | 20 | |
Common Stock Price Range | 20 | |
Dividend Policy | 20 | |
Capitalization | 21 | |
Dilution | 22 | |
Unaudited Condensed Pro Forma Financial Statements | 23 | |
Selected Consolidated Financial and Other Data | 27 | |
Management's Discussion and Analysis of Financial Condition and Results of Operations | 29 | |
Business | 50 | |
Management | 58 | |
Principal Stockholders | 67 | |
Certain Relationships and Related Transactions | 70 | |
Description of Capital Stock | 71 | |
United States Federal Income Tax Consequences to Non-United States Holders | 73 | |
Shares Eligible for Future Sale | 76 | |
Underwriting | 78 | |
Legal Matters | 82 | |
Experts | 82 | |
Where You Can Find More Information | 82 | |
Index to Consolidated Financial Statements | F-1 |
NOTICE TO RESIDENTS OF THE UNITED KINGDOM
THIS PROSPECTUS MAY ONLY BE COMMUNICATED OR CAUSED TO BE COMMUNICATED IN THE UNITED KINGDOM TO PERSONS AUTHORISED TO CARRY ON A REGULATED ACTIVITY ("AUTHORISED PERSONS") UNDER THE FINANCIAL SERVICES AND MARKETS ACT 2000 ("FSMA") OR TO PERSONS OTHERWISE HAVING PROFESSIONAL EXPERIENCE IN MATTERS RELATING TO INVESTMENTS AND QUALIFYING AS INVESTMENT PROFESSIONALS UNDER ARTICLE 19 OF THE FINANCIAL SERVICES AND MARKETS ACT 2000 (FINANCIAL PROMOTION) ORDER 2001, AS AMENDED OR TO PERSONS QUALIFYING AS HIGH NET WORTH PERSONS UNDER ARTICLE 49 OF THAT ORDER OR TO ANY OTHER PERSON TO WHOM THIS PROSPECTUS MAY OTHERWISE LAWFULLY BE COMMUNICATED OR CAUSED TO BE COMMUNICATED.
NO PROSPECTUS RELATING TO THE INTERESTS HAS BEEN REGISTERED IN THE UNITED KINGDOM AND ACCORDINGLY, THE INTERESTS MAY NOT BE, AND ARE NOT BEING, OFFERED IN THE UNITED KINGDOM EXCEPT TO PERSONS WHOSE ORDINARY ACTIVITIES INVOLVE THEM IN ACQUIRING, HOLDING, MANAGING OR DISPOSING OF INVESTMENTS (AS PRINCIPAL OR AGENT) FOR THE PURPOSES OF THEIR BUSINESS OR EXCEPT IN CIRCUMSTANCES WHICH WOULD NOT RESULT IN AN OFFER TO THE PUBLIC IN THE UNITED KINGDOM WITHIN THE MEANING OF THE PUBLIC OFFERS OF SECURITIES REGULATIONS 1995, AS AMENDED.
NEITHER THIS PROSPECTUS NOR THE COMMON STOCK REFERRED TO ARE OR WILL BE AVAILABLE TO OTHER CATEGORIES OF PERSONS IN THE UNITED KINGDOM AND NO ONE FALLING OUTSIDE SUCH CATEGORIES IS ENTITLED TO RELY ON, AND THEY MUST NOT ACT ON, ANY INFORMATION IN THIS PROSPECTUS. THE COMMUNICATION OF THIS PROSPECTUS TO ANY PERSON IN THE UNITED KINGDOM OTHER THAN THE CATEGORIES STATED ABOVE IS UNAUTHORIZED AND MAY CONTRAVENE FSMA.
The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements and notes thereto appearing elsewhere in this prospectus. Before you decide to invest in our common stock, you should read the entire prospectus carefully, including the risk factors and financial statements and related notes included in this prospectus. All references to "we," "us," "our" or "Cogent" refer to Cogent Communications Group, Inc. and its consolidated subsidiaries.
Overview
We are a leading facilities-based provider of low-cost, high-speed Internet access and Internet Protocol connectivity. Our network has been designed and optimized to transmit data using Internet Protocol, which provides us with significant cost and performance advantages over legacy networks. We deliver our services to more than 5,000 small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations in North America and Europe. Our primary service is providing Internet access at a speed of 100 Megabits per second, much faster than typical Internet access currently offered to businesses, and is delivered through our own facilities running 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 intercity transport facilities. The network is physically connected entirely through our facilities to over 950 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 colocation facilities, data centers and single-tenant office buildings. Because of our network architecture, we are not dependent on local telephone companies to serve our on-net customers. In addition to providing our on-net services, we also provide Internet connectivity to customers that are not located in buildings directly connected to our network. 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 emphasize the sale of on-net services because sales of these services generate higher gross profit margins. For the six months ended June 30, 2003, 53.1% of our net service revenue was generated from on-net customers compared to 65.6% in the same period in 2004. For the six months ended June 30, 2003, 26.1% and 20.8% of our net service revenue was generated from off-net customers and non-core customers, respectively, compared to 22.3% and 12.1% in the same period in 2004.
We have created our network by purchasing dark fiber from carriers with large unused capacity, by constructing facilities and by acquiring financially distressed companies or their assets at a significant discount to their original cost. Our intercity network consists of more than 21,000 fiber route miles and operates at between 40 and 80 Gigabits per second. Our metropolitan area networks in 25 markets in North America and Europe consist of over 8,000 fiber miles and over 150 operational rings with each ring configured to operate at between 12 and 80 Gigabits per second. Our in-building networks consist of one or more racks of equipment installed in each building with in-building riser connectivity ranging from 12 to 288 strands of fiber. Our network was constructed with dark fiber facilities that we control and have activated. Our fiber facilities are primarily obtained through long-term indefeasible rights of use, or IRUs.
Our network allows us to respond to the growing demand for low-cost, high-speed Internet connectivity. On average, we currently serve approximately 4% of the tenants in each of our multi-tenant on-net buildings. We believe these buildings have an average of 45 tenants. In addition, we currently serve less than 1% of the approximately 172,000 small and medium-sized businesses in the geographic regions in which we offer our off-net services. We also operate 29 data centers comprising over 300,000 square feet throughout North America and Europe that allow customers to colocate their
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equipment and access our network. We intend to continue to expand our addressable market by selectively adding buildings to our network.
We have grown our gross profit from a negative $17.0 million for the year ended December 31, 2001 to $12.4 million for the year ended December 31, 2003 and from $6.8 million for the six months ended June 30, 2003 to $12.3 million for the six months ended June 30, 2004. Our gross profit margin has expanded from 21% in 2003 to 30% for the six months ended June 30, 2004. However, since we initiated operations in 2000, we have generated increasing operating losses, had negative cash flows and as of June 30, 2004 had an accumulated deficit of $100.4 million.
Competitive Advantages
We believe we address many of the Internet Protocol, or IP, data communications needs of small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations by offering them high-quality Internet service at attractive prices.
Low Cost of Operation. We have built our network on a facilities-based platform, which we believe gives us a cost advantage over our competitors who have constructed their networks to overlay legacy voice networks. We have designed our high-speed network to allow us to add customers with minimal incremental investment, giving us the flexibility to offer our high speed service at a competitive price. However, certain of our competitors operating legacy networks offer services at lower access speeds and lower prices than our on-net services.
Independent Network. Our high-speed on-net Internet access service does not rely on infrastructure controlled by local incumbent telephone companies. This gives us more control over our service, quality and pricing and allows us to provision services more quickly and efficiently.
Reliable Service. Over the last 33 months, our network has averaged 99.99% customer connection availability. We have achieved this in part because our on-net customers are connected to metropolitan network rings that permit service to be maintained even if a fiber cut occurs in the ring.
High Quality. We are able to offer high-quality Internet service due to our network, which was designed solely to transmit IP data, and dedicated intracity bandwidth for each customer. Because our network was designed specifically to support our Internet service offerings, it does not support legacy services such as circuit-switched voice or frame relay.
Experienced Management Team. Our management team has designed and built our network, integrated the network assets, customers and service offerings we acquired through eight major and three minor acquisitions and has guided us through the recent telecommunications industry downturn.
Our Strategy
We intend to become the leading provider of high-capacity IP data services to customers in the markets we serve and to increase 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 leverage our high-capacity network to respond to the growing demand among businesses for high-speed Internet service.
Pursuing On-Net Customer Growth. We estimate that we now serve only 4% of the tenants in our on-net buildings and 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, particularly in Europe.
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Selectively Expanding Our Service Offerings. We will continue to evaluate opportunities to offer complementary application services on our network, such as voice-over-Internet Protocol, or VoIP, remote storage, Internet Protocol virtual private networks, or IP VPNs, and secure networks. In certain instances, the development and deployment of new technologies may be dependent on the successful implementation of network upgrades. The success of new service offerings also may be dependent on customer acceptance.
Selectively Pursuing Acquisition Opportunities. We will continue to evaluate opportunities to acquire network assets and customers through selective acquisitions.
The Reverse Stock Split and Equity Conversion
Immediately prior to this offering, we will implement a 1-for-20 reverse stock split under which the outstanding 16,145,918 shares of our common stock will be combined into 807,296 shares of our common stock, which we refer to as the Reverse Stock Split, and an equity conversion under which the outstanding shares of our preferred stock will be converted into 25,879,114 shares of our common stock on a post-Reverse Stock Split basis, which we refer to as the Equity Conversion. As a result of the Reverse Stock Split and Equity Conversion and without regard to the shares to be issued in this offering, we will have 26,686,410 shares of common stock outstanding and no shares of preferred stock outstanding immediately prior to the offering.
Company Information
We were incorporated in Delaware in August 1999. In February 2002, in connection with our merger with Allied Riser Communications Corporation, shares of our common stock started public trading on the American Stock Exchange and we became subject to, and commenced reporting under, the Securities and Exchange Act of 1934. Our principal executive offices are located at 1015 31st Street N.W., Washington, D.C. 20007. Our telephone number is (202) 295-4200 and our web site address is www.cogentco.com. The information contained, referenced or incorporated in our web site is not a part of this prospectus.
Industry Data
Information contained in this prospectus about our position in our industry is based on market studies published by two independent third parties. These studies indicate that we are among the top three providers in our industry based upon network capacity, IP address control and the number of peering arrangements held. While we believe that they are reliable, we have not independently verified the industry data provided by these third party sources.
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Common stock offered by us to the public | shares | |
Common stock offered by us to the participating stockholders | shares | |
Common stock to be outstanding after this offering |
shares |
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Use of proceeds |
We intend to use the proceeds that we receive from this offering to repay $7.0 million of our aggregate of $17.0 million of indebtedness to Cisco, to fund the expansion of our sales and marketing efforts, to fund the increase in the number of on-net buildings we serve and for general corporate purposes, which may include potential acquisitions of complementary businesses. See "Use of Proceeds." |
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American Stock Exchange symbol |
"COI" |
The number of shares of our common stock that will be outstanding after this offering reflects our Reverse Stock Split, is based on shares outstanding as of September 15, 2004 and includes:
The number of shares of our common stock that will be outstanding after this offering excludes:
Unless we specifically state otherwise, all information in this prospectus assumes:
You should carefully read and consider the information set forth in "Risk Factors" and all other information set forth in this prospectus before investing in our common stock.
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Summary Consolidated Financial and Other Data
The following summary historical and pro forma financial information should be read in conjunction with "Selected Consolidated Financial and Other Data," "Unaudited Condensed Pro Forma Financial Statements," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our historical financial statements and other related notes included elsewhere in this prospectus. The period-to-period comparability of our historical results is materially affected by several significant acquisitions. These acquisitions and their effect on our business are described in "Management's Discussion and Analysis of Financial Condition and Results of OperationsAcquisitions."
The pro forma statement of operations data and other financial data presented below give effect to the acquisition of Firstmark Communications Participations S.à r.l. as if it had occurred as of January 1, 2003. The Firstmark acquisition was consummated on January 5, 2004. Since the Firstmark results of operations for the period from January 1, 2004 through January 4, 2004 are not material, a pro forma statement of operations for the six months ended June 30, 2004 is not required to be presented.
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Pro Forma |
Six Months Ended June 30, |
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Year Ended December 31, |
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Year Ended December 31, 2003 |
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2001 |
2002 |
2003 |
2003 |
2004 |
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(unaudited) |
(unaudited) |
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(in thousands, except operating data) |
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Statement of Operations Data: | |||||||||||||||||||||
Net service revenue | $ | 3,018 | $ | 51,913 | $ | 59,422 | $ | 85,953 | $ | 29,751 | $ | 41,332 | |||||||||
Operating expenses: | |||||||||||||||||||||
Cost of network operations | 19,990 | 49,091 | 47,017 | 59,910 | 22,913 | 29,008 | |||||||||||||||
Amortization of deferred compensation cost of network operations | 307 | 233 | 1,307 | 1,307 | 108 | 425 | |||||||||||||||
Selling, general, and administrative | 27,322 | 33,495 | 26,570 | 48,719 | 13,702 | 19,119 | |||||||||||||||
Amortization of deferred compensation selling, general, and administrative | 2,958 | 3,098 | 17,368 | 17,368 | 1,440 | 5,652 | |||||||||||||||
Asset impairment and loss | | | | 3,279 | | | |||||||||||||||
Gain on settlement of vendor litigation | | (5,721 | ) | | | | | ||||||||||||||
Depreciation and amortization | 13,535 | 33,990 | 48,387 | 55,835 | 23,038 | 28,285 | |||||||||||||||
Total operating expenses | 64,112 | 114,186 | 140,649 | 186,418 | 61,201 | 82,489 | |||||||||||||||
Operating loss | (61,094 | ) | (62,273 | ) | (81,227 | ) | (100,465 | ) | (31,450 | ) | (41,157 | ) | |||||||||
Gains on debt extinguishment | | | 240,234 | 345,517 | 24,802 | | |||||||||||||||
Settlement of noteholder litigation | | (3,468 | ) | | | | | ||||||||||||||
Interest income (expense) and other, net | (5,819 | ) | (34,545 | ) | (18,264 | ) | (26,493 | ) | (14,234 | ) | (5,238 | ) | |||||||||
(Loss) income before extraordinary item | (66,913 | ) | (100,286 | ) | 140,743 | 218,559 | (20,882 | ) | (46,395 | ) | |||||||||||
Extraordinary gain Allied Riser merger | | 8,443 | | | | | |||||||||||||||
Net (loss) income before cumulative effect of accounting change | (66,913 | ) | (91,843 | ) | 140,743 | 218,559 | (20,882 | ) | (46,395 | ) | |||||||||||
Cumulative effect on prior years SFAS 143 | | | | (289 | ) | | | ||||||||||||||
Net (loss) income | (66,913 | ) | (91,843 | ) | 140,743 | 218,270 | (20,882 | ) | (46,395 | ) | |||||||||||
Beneficial conversion of preferred stock | (24,168 | ) | | (52,000 | ) | (54,575 | ) | | (22,028 | ) | |||||||||||
Net (loss) income applicable to common stock | $ | (91,081 | ) | $ | (91,843 | ) | $ | 88,743 | $ | 163,695 | $ | (20,882 | ) | $ | (68,423 | ) | |||||
Other Financial Data: |
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Capital expenditures | $ | 118,020 | $ | 75,214 | $ | 24,016 | $ | 18,297 | $ | 4,038 | |||||||||||
Net cash used in operating activities | (46,786 | ) | (41,567 | ) | (27,357 | ) | (18,763 | ) | (17,629 | ) | |||||||||||
Net cash (used in) provided by investing activities | (131,652 | ) | (19,786 | ) | (25,316 | ) | (16,258 | ) | 26,480 | ||||||||||||
Net cash provided by (used in) financing activities | 161,862 | 51,694 | 20,562 | 1,398 | (3,308 | ) |
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As of and for the Year Ended December 31, |
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As of and for the Six Months Ended June 30, |
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2001 |
2002 |
2003 |
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2003 |
2004 |
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(unaudited) |
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Operating Data: | ||||||||||||||
Percent of revenue on-net | 59.7% | 31.9% | 55.6% | 53.1% | 65.6% | |||||||||
Percent of revenue off-net | 40.3% | 40.7% | 26.4% | 26.1% | 22.3% | |||||||||
Percent of revenue non-core | | 27.4% | 18.0% | 20.8% | 12.1% | |||||||||
On-net customer connections |
189 |
881 |
1,649 |
1,032 |
2,258 |
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On-net buildings | 127 | 511 | 813 | 719 | 926 | |||||||||
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June 30, 2004 |
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Actual |
As Adjusted |
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(unaudited) |
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(in thousands) |
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Balance Sheet Data: | ||||||||
Cash and cash equivalents and short-term investments ($740, restricted) | $ | 14,839 | $ | 54,589 | ||||
Working capital (deficit) | (3,479 | ) | 36,271 | |||||
Property and equipment, net | 346,643 | 346,643 | ||||||
Total assets | 383,310 | 423,060 | ||||||
Capital lease obligations | 108,513 | 108,513 | ||||||
Long term notes payable (net of discount of $5,606) | 22,427 | 15,080 | ||||||
Convertible preferred stock | 114,672 | | ||||||
Stockholders' equity | 226,078 | 273,175 |
The as adjusted balance sheet data presented above gives effect to the completion of this offering and the application of proceeds as set forth in "Use of Proceeds" as if this offering had occurred as of June 30, 2004.
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Investing in our common stock involves risk. You should carefully consider the following risks as well as the other information contained in this prospectus, including our financial statements and the related notes, before investing in our common stock. The occurrence of any of the risks identified below could have a material adverse effect on our business, results of operations and financial condition and could cause sharp declines in the price of our common stock.
Risks Related to Our Business
If our operations do not produce positive cash flow to pay for our growth or meet our 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 and to implement our plans to grow our business. We may also face unforeseen capital requirements for new technology required to remain competitive and for unforeseen maintenance of our network and facilities. Given the recent condition of the financial markets, it has been very difficult to raise capital, especially for telecommunications companies. We cannot assure you that access to additional capital will become any easier in the future, nor can we assure you that any such financing will be available on terms that are acceptable to us or our stockholders. If additional funds are raised by issuing equity securities, substantial dilution to existing stockholders may result.
We need to increase the number of our customers in order to become profitable and cash-flow positive.
In order to become profitable and cash flow positive, we need to keep the customers we have and continue to add new customers. We anticipate the need to add a large number of additional customers, however, 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. This could happen if our sales and marketing plan is unsuccessful, we hire the wrong sales force to implement the sales and marketing plan, or we are unable to retain a high-quality sales force.
We have historically incurred operating losses and these losses may continue for the foreseeable future.
Since we initiated operations in 2000, we have generated increasing operating losses and these losses may continue for the foreseeable future. In 2001, we had an operating loss of $61.1 million, in 2002 we had an operating loss of $62.3 million, in 2003 we had an operating loss of $81.2 million, and during the first six months of 2004, we had an operating loss of $41.2 million. As of June 30, 2004, we had an accumulated deficit of $100.4 million. Continued losses may prevent us from pursuing our strategies for growth or 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 a relatively small company in an industry that is capital intensive, rapidly evolving and affected by economies of scale. If we fail to grow, we may not be able to successfully compete with larger, better-established companies.
Because the communications industry is capital intensive, rapidly evolving and includes competitors with significant economies of scale, as a relatively small organization, we are at a competitive disadvantage. The growth we must achieve to reduce that disadvantage will put a significant strain on all of our resources. Our ability to sustain our current operations and to achieve the growth that we believe will be necessary for us to achieve profitability will depend on a number of factors, including
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our success in increasing the number of customers we serve, the expenses associated with the maintenance of our network and adding new on-net buildings to our network, regulatory changes, the levels of competition that we face, technological developments, merger and acquisition activity and condition of the North American and European economies and their ability to recover from the recent downturn.
We may not be able to efficiently manage our growth.
We have grown our company through acquisitions of companies, assets and customers as well as implementation of our own network expansion and sales efforts. Our future largely depends on our ability to continue taking advantage of these types of opportunities as they arise. This continued expansion will place significant strains on our personnel, financial and other resources. The failure to efficiently manage our growth could adversely affect the quality of our services, our business and our financial condition. Our ability to manage our growth will be particularly dependent on our ability to develop and retain an effective sales force and qualified technical and managerial personnel. We may not be able to hire and retain sufficient numbers of qualified personnel, maintain the quality of our operations, control our costs, maintain compliance with all applicable regulations or expand our internal management, technical, information and accounting systems in order to support our desired growth. In addition, we must achieve the steps necessary to manage our growth in a timely manner, at reasonable costs and on satisfactory terms and conditions. Failure to effectively manage our planned expansion could have a material adverse effect on our business, growth, financial condition, results of operations, and ability to meet our obligations.
We may incur unexpected costs, customer and revenue erosion and may not realize the benefits we anticipate, from our recent acquisitions in Europe.
We recently 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 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. The assets that were part of Carrier 1 have not yet been fully integrated into our network. We may incur additional and unexpected costs in amounts we cannot predict and operating difficulties in fully integrating these European operations and assets with our strategies, technologies, information systems and services.
LambdaNet France and LambdaNet Spain operated a combined telecommunications network and shared operations systems with a formerly affiliated entity, LambdaNet Germany. Because we did not acquire LambdaNet Germany, we are now in the process of separating the operations of LambdaNet Germany from the LambdaNet companies we acquired, which includes settling claims for intercompany receivables due to and from LambdaNet France and LambdaNet Spain. Our failure to efficiently accomplish this task would subject us to additional expenses.
In addition, we expect to experience material erosion of revenue acquired with our European subsidiaries. This expectation is based in part on the indication from a number of customers of our French and Spanish operations that they will not continue to purchase our services after the expiration of their current contractual obligations. Our recent operating results reflect some of this anticipated revenue erosion as net service revenue attributable to Firstmark during the three months ended June 30, 2004 declined by $0.6 million, or 10.1% compared to the previous three months. We expect to experience further revenue erosion as certain Firstmark customers have indicated to us that they will not continue to purchase, or will reduce their purchases of, Firstmark's services after the expiration of their current contractual obligations. In 2003 revenue under contracts with these customers represented approximately euro 3.8 million of the total euro 23.5 million revenue of Firstmark.
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We may experience delays and additional costs in completing the activation of our network in Germany.
We are in the process of activating our German network and interconnecting it with our network in France. We are experiencing delays in completing activation of the full German network, due primarily to logistical issues with the finalization of various POP licenses. We may continue to experience delays and unanticipated costs as we begin to add customers to the German network for reasons we do not foresee because of our inexperience in operating and installing equipment and providing services in the German market.
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. We have already completed eleven acquisitions, including nine in the last two years. We compete with other companies for these 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:
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, in connection with each of our acquisitions in which we have acquired customer contracts, some portion of these customers have elected not to continue purchasing services from us. Accordingly, historical operating results from the acquired businesses or assets have not been indicative of our combined results as we have experienced, and expect to continue to experience, material erosion of revenue from these sources. Our recent operating results are illustrative of this trend as net service revenue attributable to customer contracts
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acquired in the PSINet and FNSI transactions declined by $6.2 million, or 116.2% during the six months ended June 30, 2004 compared to the previous six-month period.
Our substantial debt may adversely affect our financial condition and operating activity.
We have, and after the completion of this offering will continue to have, substantial debt and substantial debt service obligations. At June 30, 2004, as adjusted to give effect to this offering and the application of the proceeds of this offering to repay $7.0 million of our $17.0 million of total indebtedness to Cisco Systems Capital Corporation, we would have had outstanding indebtedness of approximately $10.2 million in face value under our 71/2% Convertible Subordinated Notes Due 2007, $10.0 million of indebtedness to Cisco Systems Capital Corporation and approximately $108.5 million of obligations under capital leases.
Our level of indebtedness has important consequences to you, including:
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 President 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 make him particularly well-suited to lead our company.
Our European operations expose us to economic, regulatory and other risks.
The nature of our European business involves a number of other risks, including:
As we continue to expand our European 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 operations may have a material adverse effect on our business and results of operations.
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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 close and 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. Migration of acquired operations onto our information systems is an ongoing process that we have been able to manage with minimal negative impact on our operations or customers. However, due to the greater variance between non-U.S. information systems and our primary systems, the integration of our new European operations could increase the likelihood that these systems do not perform as desired. 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.
Our intercity and intracity dark fiber is maintained by the carriers from whom it has been obtained. While we have not experienced material problems with interruption of service in the past, if these carriers fail to maintain the fiber or disrupt our fiber connections for other reasons, such as business disputes with us or governmental takings, our ability to provide service in the affected markets or parts of markets would be impaired. We may incur significant delays and costs in restoring service to our customers, and we may lose customers if delays are substantial.
Our rights to the use of the dark fiber that makes up our network may be affected by the financial health of our fiber providers.
We do not have title to most of the dark fiber that makes up the foundation of our network. Our interests in that dark fiber are in the form of long-term leases or IRUs. We have made substantial advance payments pursuant to these IRUs for the long-term use of the dark fiber. There has been increasing financial pressure on some of our fiber providers as part of the overall weakening of the telecommunications market over the past several years. Our largest supplier of our metropolitan fiber networks, AboveNet (formerly known as Metromedia Fiber Network Services, Inc.), and our primary supplier of our national backbone fiber, WilTel Communications (formerly known as Williams Communications, Inc.), each recently emerged from bankruptcy. The future bankruptcy or other insolvency of AboveNet, WilTel or one or more of the other entities with which we have entered into IRUs could significantly and adversely impact our results of operations. For example, bankruptcies or
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insolvencies could result in a loss of our rights to use the fiber pursuant to our IRUs. If this occurred we would need to obtain alternative fiber capacity in order to continue to transmit data over the affected portion of our network. We cannot assure you that we would be able to obtain such alternative capacity in a timely manner, on reasonable terms or at all, as there may be locations where alternate providers do not exist. Even if we were able to continue to use the fiber subject to such IRUs upon the bankruptcy or insolvency of one or more of our fiber suppliers, these suppliers may cease providing certain other services under the IRUs that we currently rely upon. This may, among other things, require us to expend additional funds for maintenance of the fiber or directly fund right-of-way obligations.
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. 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 no single building access agreement is material to our success, the failure to obtain or maintain a larger 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 regard certain aspects of our business as proprietary and attempt to protect them through trade secret laws, restrictions on disclosure and other methods. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use this information.
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.
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The sector in which we operate is highly competitive, and we may not be able to compete effectively.
We face significant competition from traditional and new communications companies, including companies that provide local and long distance telephone services, cable modem services, Internet connectivity, digital subscriber line services, fixed and mobile wireless services and satellite data services. Relative to us, traditional providers have significantly greater financial resources, more well-established brand names, larger customer bases, more diverse strategic plans and technologies.
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 diminished the competitive advantage that we have enjoyed as a result of our service pricing. If our competitors successfully focus on our target markets, this key advantage may be further eroded and our business may suffer.
Some of our competitors are in bankruptcy or may soon emerge from bankruptcy, and some already have done so. Because the bankruptcy process allows for the discharge of debts and rejection of certain obligations, these competitors may have more pricing flexibility and a lower cost structure than we do.
Our quarterly operating results are subject to substantial fluctuations and you should not rely on them as an indication of our future results.
In the past our quarterly operating results have fluctuated dramatically based largely on one-time events, such as acquisitions, gains from debt restructurings, other initiatives and the erosion of non-core revenues. Some of these fluctuations were predictable, but some were unforeseen. During the six quarters ended June 30, 2004, our net service revenues, operating loss and net income (loss) varied significantly as illustrated in the following table.
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Three Months Ended |
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Operating Measure |
March 31, 2003 |
June 30, 2003 |
September 30, 2003 |
December 31, 2003 |
March 31, 2004 |
June 30, 2004 |
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Net service revenue | $ | 14,233 | $ | 15,519 | $ | 15,148 | $ | 14,522 | $ | 20,945 | $ | 20,387 | |||||||
Operating loss | $ | (14,880 | ) | $ | (16,568 | ) | $ | (15,901 | ) | $ | (33,878 | ) | $ | (21,939 | ) | $ | (19,218 | ) | |
Net income (loss) | $ | 1,914 | $ | (22,796 | ) | $ | 196,462 | $ | (34,837 | ) | $ | (24,170 | ) | $ | (22,225 | ) |
The factors that have caused, and that may in the future cause, such quarterly variances are numerous and may work in combination to cause such variances. These factors include:
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Many of these factors are beyond our control. Accordingly, our quarterly operating results may vary significantly in the future and period-to-period comparisons of our results of operations may not be meaningful and should not be relied upon as indicators of our full year performance or future performance. Our share price may be subject to greater volatility due to these fluctuations in our operating results.
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 such 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. We cannot assure you that we will be able to continue to establish and maintain those relationships. The terms and conditions of our peering relationships may also be subject to adverse changes, which we may not be able to control. If we are not able to maintain and 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 would have a material adverse effect on our business.
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.
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 may be 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 and man-made events. In addition, some of our customers are, at least initially, only served by partial fiber rings, which increases the risk of service interruption. Portions of our network and certain of our 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 be vulnerable to unauthorized access or we may incur liability for information disseminated through our network.
Our networks may be vulnerable to unauthorized access, computer viruses and other disruptive problems. Addressing the effects of computer viruses and alleviating other security problems may
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require interruptions, incurrence of costs and delays or cessation of service to our customers. Unauthorized access could jeopardize the security of confidential information stored in our computer systems or those of our customers, for which we could possibly be held liable.
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.
Our relationship with LNG Holdings may expose us to its liabilities and claims by its minority shareholders.
Our acquisition of Firstmark was accomplished in a series of transactions that, in one particular step, involved the purchase of approximately 90% of the equity of Firstmark's parent company, LNG Holdings, by an entity owned and controlled by our Chief Executive Officer, Dave Schaeffer. Mr. Schaeffer continues to hold this equity interest in LNG Holdings. Additionally, in connection with the acquisition, we agreed to indemnify LNG Holdings' former stockholders against certain claims. Although we do not anticipate that any material liabilities affecting us could arise either through Mr. Schaeffer's role in the transaction or his continued ownership of LNG Holdings, our transactions with LNG Holdings, or through our indemnification of the former LNG Holdings stockholders, we cannot assure you that any liabilities that might arise would not have a material adverse affect on our business, results of operations and financial condition.
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. 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.
Risks Related to Our Common Stock and this Offering
We cannot assure you that an active trading market will develop for our stock.
The portion of our common stock that is currently publicly traded on the American Stock Exchange represents less than 3.0% of our issued and outstanding capital stock on a fully diluted basis. Additionally, since shares of our common stock started trading on the American Stock Exchange in February 2002, trading volume in shares of our common stock has remained relatively low with an
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average daily volume since January 1, 2003 of less than 41,000 shares. While this offering will greatly increase the number of our shares of common stock that are publicly tradable, we cannot assure you that an active public market for our common stock will develop or be sustained after this offering. If a market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at a price that is attractive to you or at all.
You will incur immediate and substantial dilution.
The public offering price of our common stock will be substantially higher than the net tangible book value per share of our outstanding common stock. Accordingly, if you purchase common stock in this offering, you will suffer immediate and substantial dilution of your investment. Based upon the issuance and sale of million shares of common stock by us at an assumed offering price of $ per share, you will incur immediate dilution of approximately $ in the net tangible book value per share.
After the offering, our affiliates will continue to hold a sufficient number of shares of our common stock to control all matters requiring a stockholder vote and, as a result, could prevent or delay any strategic transaction.
After the offering, our executive officers, certain entities affiliated with members of our board of directors, our existing greater-than-five-percent stockholders and their affiliates will in the aggregate beneficially own approximately % of our common stock, which is sufficient to decide the outcome of all matters requiring a stockholder vote. They have the ability to exert significant influence over the company. For instance, these stockholders are able to control the outcome of votes concerning director elections, amendments to our certificate of incorporation and bylaws, mergers, corporate control contests and other significant corporate transactions including a change of control or going private transaction. Although we do not foresee such a transaction at the present time, the concentration of our stock ownership could have the effect of preventing or delaying a change of control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could harm the market price of our common stock and prevent our stockholders from realizing a takeover premium over the market price for their shares of common stock.
Future sales of shares of our common stock by existing stockholders in the public market, or the possibility or perception of such future sales, could adversely affect the market price of our stock.
The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market after this offering or the perception that these sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for you to sell your shares of common stock at a time and at a price which you deem appropriate.
As of August 31, 2004, there were 807,296 shares of our common stock outstanding. The million shares of common stock sold in this offering ( million shares if the underwriters exercise their over-allotment option in full) will be freely tradeable without restriction or further registration under the Securities Act of 1933, as amended, by persons other than our affiliates within the meaning of Rule 144 under the Securities Act.
Following this offering, our executive officers, directors and persons who currently hold preferred shares, will own million shares of our common stock, or shares if the underwriters exercise their over-allotment option in full. Each of these persons will be able to sell shares in the public market from time to time, subject to certain limitations on the timing, amount and method of those sales imposed by SEC regulations. These persons and the underwriters have agreed to a "lock-up" period, meaning that they may not sell any of their shares after the offering without the prior consent of Jefferies & Company, Inc. for at least one year after the date of this prospectus, except that sales
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pursuant to a firm commitment underwriting of shares held by these persons is permitted 180 days after the date of this prospectus. These affiliates also have the right to cause us to register the sale of shares of common stock that they own and to include such shares in future registration statements relating to our securities. If these affiliates were to sell a large number of their shares, the market price of our stock could decline significantly. In addition, the perception in the public markets that sales by these affiliates might occur could also adversely affect the market price of our common stock.
Although there is no present intention or arrangement to do so, all or any portion of the shares may be released from the restrictions in the lock-up agreements and those shares would then be available for resale in the market. Any release would be considered on a case-by-case basis.
The market price of our common stock may be volatile, which could cause the value of your investment to decline.
Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as general economic, market or political conditions, could reduce the market price of our common stock in spite of our operating performance. In addition, our operating results could be below the expectations of public market analysts and investors, and in response, the market price of our common stock could decrease significantly. You may be unable to resell your shares of our common stock at or above the public offering price.
Because we do not intend to pay dividends, stockholders will benefit from an investment in our common stock only if it appreciates in value.
We currently intend to retain our future earnings, if any, to finance the further expansion and continued growth of our business and do not expect to pay any cash dividends in the foreseeable future. As a result, the success of an investment in our common stock will depend upon any future appreciation in its value. There is no guarantee that our common stock will appreciate in value or even maintain the price at which stockholders have purchased their shares.
We may apply the net proceeds of this offering to uses that do not improve our operating results or increase the value of your investment.
Our board and management will have considerable discretion in the application of the net proceeds of this offering, and you will not have the opportunity, as part of your investment decision, to assess how the proceeds will be used. The net proceeds may be used for corporate purposes that do not improve our operating results or market value, and you will not have the opportunity to evaluate the economic, financial or other information on which we base our decisions on how to use the proceeds.
Arthur Andersen LLP, the auditor for our audited financial statements for the year ended December 31, 2001 and for the audited financial statements of our subsidiary Allied Riser for the years ended 1999, 2000 and 2001 that are included in this prospectus, has been found guilty of federal obstruction of justice charges and you are unlikely to be able to exercise effective remedies against them in any legal action.
On June 15, 2002, a jury in Houston, Texas found our former independent public accountant, Arthur Andersen LLP, guilty of federal obstruction of justice charges arising from the federal government's investigation of Enron Corp. As a result, Arthur Andersen has ceased practicing before the SEC and substantially all of Arthur Andersen's personnel have left the firm, including the individuals responsible for auditing our financial statements for the year ended December 31, 2001 and the audited financial statements of our subsidiary Allied Riser for the years ended December 31, 1999, 2000 and 2001 that are included in this prospectus. Arthur Andersen was our independent auditor for the years ended 1999 through 2001, and Allied Riser's independent auditor for the years ended 1996
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through 2001. However, on November 13, 2002, we dismissed Arthur Andersen and appointed Ernst & Young LLP as our independent auditors. Arthur Andersen is currently in the process of liquidating its assets. The ability of Arthur Andersen to satisfy any judgments obtained against them is in great doubt and, therefore, you are unlikely to be able to exercise effective remedies or collect judgments against them.
Moreover, as a public company, we are required to file with the SEC financial statements audited or reviewed by an independent public accountant. The SEC issued a statement that it will continue to accept financial statements audited by Arthur Andersen on an interim basis if Arthur Andersen is able to make certain representations to its clients concerning audit quality controls. Arthur Andersen has made such representations to us in the past. However, for the reasons noted above, Arthur Andersen will be unable to make these representations in the future or to provide other information or documents that would customarily be received by us or the underwriters in connection with this offering, including consents and "comfort letters." In addition, Arthur Andersen will be unable to perform procedures to assure the continued accuracy of its report on our audited financial statements included in this prospectus. Arthur Andersen will be unable to provide such information and documents and perform such procedures in future financings and other transactions. As a result, we may encounter delays, additional expense and other difficulties in this offering, future financings or other transactions.
In reliance on Rule 437a under the Securities Act, we have not filed a written consent of Arthur Andersen to the inclusion in this prospectus of their reports regarding our financial statements for the year ended December 31, 2001 nor the financial statements of Allied Riser for the years ended December 31, 1999, 2000 and 2001. Because we have not filed the written consent of Arthur Andersen with respect to the inclusion of their reports in this prospectus, you may not be able to recover against Arthur Andersen under Section 1 of the Securities Act for any untrue statements of material fact contained in the financial statements audited by Arthur Andersen or any omissions to state a material fact required to be stated therein.
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act relating to our operations that are based on current estimates, expectations and projections. Words such as "believes," "expects," "potential," "continues," "may," "will," "should," "seeks," "approximately," "predicts," "intends," "plans," "estimates," and "anticipates" are used to identify many of these forward-looking statements. Such forward-looking statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict and assumptions that may not prove to be accurate. Actual outcomes and results may differ materially from what is expressed or forecast in these forward-looking statements. The reasons for this include changes in general economic conditions or the factors described under "Risk Factors."
SPECIAL NOTE REGARDING ARTHUR ANDERSEN LLP
Section 11(a) of the Securities Act provides that if any part of a registration statement at the time it becomes effective contains an untrue statement of a material fact or an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring a security pursuant to such registration statement (unless it is proved that at the time of such acquisition such person knew of such untruth or omission) may sue, among others, every accountant who has consented to be named as having prepared or certified any part of the registration statement or as having prepared or certified any report or valuation which is used in connection with the registration statement with respect to the statement in such registration statement, report or valuation which purports to have been prepared or certified by the accountant.
Arthur Andersen LLP audited our financial statements for the period from August 9, 1999 to December 31, 1999 and the years ended December 31, 2000 and 2001 and the financial statements of our subsidiary Allied Riser for the years ended December 31, 1999, 2000 and 2001. Prior to the date of this prospectus, the Arthur Andersen partners who audited those financial statements resigned from Arthur Andersen. As a result, after reasonable efforts, we have been unable to obtain Arthur Andersen's written consent to the inclusion in this registration statement of its audit reports with respect to our financial statements for the year ended December 31, 2001 and to the financial statements of Allied Riser for the years ended December 31, 1999, 2000 and 2001. Under these circumstances, Rule 437a under the Securities Act permits us to file this registration statement without written consents from Arthur Andersen. Accordingly, Arthur Andersen may not be liable to you under Section 11(a) of the Securities Act because it has not consented to being named as an expert in the registration statement.
19
We estimate that we will receive net proceeds from this offering of approximately $46.8 million, after deducting underwriting discounts and commissions and other estimated expenses of $3.3 million payable by us. We will use a portion of the net proceeds of this offering to repay $7.0 million of our total indebtedness to Cisco, which was $17.0 million as of June 30, 2004. When the indebtedness under the Second Amended and Restated Cisco Credit Agreement, which was entered into in connection with this offering, begins to accrue interest in February 2006, it will accrue at the 90-day LIBOR rate plus 4.5% until maturity on February 1, 2008. For more information on the Second Amended and Restated Cisco Credit Agreement, see "Management's Discussion and Analysis of Financial Condition and ResultsLiquidity and Capital ResourcesSecond Amended and Restated Cisco Note and Second Amended and Restated Cisco Credit Agreement."
We intend to use the remaining $39.8 million of net proceeds that we receive from this offering to fund the expansion of our sales and marketing efforts, to fund the increase in the number of on-net buildings we serve by approximately 7%, primarily by adding buildings in Europe and for general corporate purposes, which may include potential acquisitions of complementary businesses.
Our common stock is currently traded on the American Stock Exchange under the symbol "COI." Prior to February 5, 2002, no established public trading market for our common stock existed.
The table below shows, for the quarters indicated, the reported high and low trading prices of our common stock on the American Stock Exchange. All sale prices presented below have not been adjusted to give effect to the Reverse Stock Split that will occur immediately prior to this offering.
|
Year Ended December 31, |
|||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2002 |
2003 |
2004(1) |
|||||||||||||||
|
High |
Low |
High |
Low |
High |
Low |
||||||||||||
First Quarter | $ | 5.05 | $ | 2.70 | $ | 0.94 | $ | 0.40 | $ | 2.74 | $ | 1.10 | ||||||
Second Quarter | 3.20 | 1.30 | 3.23 | 0.32 | 2.19 | 0.27 | ||||||||||||
Third Quarter | 1.43 | 0.95 | 2.39 | 0.80 | 0.40 | 0.23 | ||||||||||||
Fourth Quarter | 1.39 | 0.27 | 1.98 | 0.95 |
The last reported sale price of our common stock on the American Stock Exchange on October 1, 2004 was $0.32 per share, which would have been $6.40 per share after giving effect to the Reverse Stock Split.
We have not paid any dividends on our common stock since our inception and do not anticipate paying any dividends in the foreseeable future. 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.
20
The following table sets forth our consolidated capitalization as of June 30, 2004:
You should read this table in conjunction with our unaudited condensed consolidated financial statements and the related notes, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Use of Proceeds" included elsewhere in this prospectus.
|
As of June 30, 2004 |
||||||||
---|---|---|---|---|---|---|---|---|---|
|
Actual |
As Adjusted(1) |
|||||||
|
(unaudited and in thousands) |
||||||||
Cash, cash equivalents and short-term investments (includes $740 restricted) | $ | 14,839 | $ | 54,589 | |||||
Debt (including current maturities): | |||||||||
Amended and Restated Cisco Note | $ | 17,842 | $ | 10,495 | |||||
Capital lease obligations | 108,513 | 108,513 | |||||||
71/2% Convertible Subordinated Notes Due 2007 (net of discount of $5,606) | 4,585 | 4,585 | |||||||
Total debt | 130,940 | 123,593 | |||||||
Stockholders' equity: |
|||||||||
Common stock, par value $0.001 per share; 30,000,000 shares authorized; 802,142 shares outstanding; shares outstanding as adjusted | 1 | ||||||||
Series F participating convertible preferred stock, par value $.001 per share; 11,000 shares authorized, issued and outstanding; no shares authorized, issued and outstanding as adjusted | 10,904 | | |||||||
Series G participating convertible preferred stock, par value $.001 per share; 41,030 shares authorized, issued and outstanding; no shares authorized, issued and outstanding as adjusted | 40,787 | | |||||||
Series H participating convertible preferred stock, par value $.001 per share; 84,001 shares authorized; 52,023 shares issued and outstanding; no shares authorized, issued and outstanding as adjusted | 41,015 | | |||||||
Series I participating convertible preferred stock, par value $.001 per share; 3,000 shares authorized 2,575 shares issued and outstanding; no shares authorized, issued and outstanding as adjusted | 2,545 | | |||||||
Series J participating convertible preferred stock, par value $.001 per share; 3,891 shares authorized, issued and outstanding; no shares authorized, issued and outstanding as adjusted | 19,421 | | |||||||
Additional paid-in capital | 235,801 | ||||||||
Deferred compensation | (24,955 | ) | (24,955 | ) | |||||
Stock purchase warrants | 764 | 764 | |||||||
Accumulated other comprehensive income | 304 | 304 | |||||||
Treasury stock, 61,462 shares | (90 | ) | (90 | ) | |||||
Accumulated deficit | (100,419 | ) | (100,072 | ) | |||||
Total stockholders' equity | 226,078 | ||||||||
Total capitalization | $ | 357,018 | $ | ||||||
21
Dilution is the amount by which the offering price paid by the purchasers of the common stock to be sold in this offering exceeds the net tangible book value per share of common stock after this offering. The net tangible book value per share is determined at any date by subtracting our total liabilities from the total book value of our tangible assets (total assets less intangible assets) and dividing the difference by the number of shares of our common stock outstanding at that date.
Our net tangible book value as of June 30, 2004 was $221.9 million, or $8.63 per share. Our pro forma net tangible book value as of June 30, 2004 gives effect to the Reverse Stock Split and Equity Conversion described in the Prospectus Summary. After giving effect to the receipt of approximately $39.8 million of estimated net proceeds from our sale of million shares of common stock in this offering at an assumed offering price of $ per share, our pro forma as adjusted net tangible book value as of June 30, 2004 would have been approximately $268.9 million, or $ per share. This represents an immediate increase in net tangible book value of $ per share to existing shareholders and an immediate dilution of $ per share to new investors purchasing shares of our common stock in this offering. The following table illustrates this substantial and immediate per share dilution to new investors:
|
Per Share |
||||||
---|---|---|---|---|---|---|---|
Assumed offering price per share | $ | ||||||
Pro forma net tangible book value before the offering | $ | 8.63 | |||||
Increase per share attributable to investors in the offering | |||||||
As adjusted net tangible book value after the offering | |||||||
Dilution per share to new investors | $ | ||||||
The following table gives effect to the Reverse Stock Split and the Equity Conversion, which will occur immediately prior to the completion of this offering, and summarizes on a pro forma as adjusted basis as of June 30, 2004:
|
Shares Purchased |
Total Consideration |
|
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Average Price Per Share |
||||||||||||
|
Number |
Percent |
Amount |
Percent |
|||||||||
|
|
|
(in thousands) |
|
|
||||||||
Pre-offering stockholders | 802,142 | % | $ | 199,177 | 61.6% | $ | 248.31 | ||||||
Converting preferred stockholders | 24,913,889 | % | 74,059 | 22.9% | 2.97 | ||||||||
Investors in the offering | % | 50,000 | 15.5% | ||||||||||
Total | 100.0% | $ | 323,236 | 100.0% | $ | ||||||||
The tables and calculations above exclude an aggregate of 1,093,304 shares of common stock that will be issued upon the conversion into common stock of our Series K preferred stock and Series L preferred stock at the time of the Equity Conversion and assumes no exercise of outstanding options or warrant to purchase an aggregate of approximately 1.0 million shares of our common stock or the rights of the holders of our 71/2% Convertible Subordinated Notes Due 2007 to convert such Notes into 1,066 shares of our common stock.
22
UNAUDITED CONDENSED PRO FORMA FINANCIAL STATEMENTS
The following unaudited condensed pro forma financial statements ("the pro forma financial statements") and explanatory notes have been prepared to give effect to the following transactions: (1) our acquisition of Firstmark on January 5, 2004, (2) the Equity Conversion, (3) the receipt of estimated net proceeds of $46.8 million from our sale of common stock in this offering and (4) the repayment of $7.0 million of our aggregate indebtedness of $17.0 million under the Amended and Restated Cisco Note with a part of the proceeds from this offering. The pro forma balance sheet as of June 30, 2004, assumes that each of these transactions except for the Firstmark acquisition occurred on June 30, 2004. The impact of the Firstmark acquisition is already reflected in our historical June 30, 2004 condensed consolidated balance sheet. The pro forma statement of operations assumes that each of these transactions occurred on January 1, 2003. Because Firstmark's results for the period from January 1, 2004 to January 4, 2004 are not material, a pro forma statement of operations for the six months ended June 30, 2004 is not required to be presented. The pro forma statement of operations for the year ended December 31, 2003 does not give effect to our February 28, 2003 acquisition of Fiber Network Services, Inc. as its results were included in our historical results from its acquisition date and the pro forma impact would not be significant. The pro forma statement of operations for the year ended December 31, 2003 also excludes our merger on March 30, 2004 with Symposium Omega, Inc. because Omega did not have any revenues, customers or employees and was not considered a business.
The following pro forma financial statements have been prepared based upon our historical financial statements and those of Firstmark. The pro forma financial statements should be read in conjunction with our historical consolidated financial statements as of December 31, 2002 and 2003 and as of June 30, 2004 and, for the years ended December 31, 2001, 2002 and 2003 and the three and six months ended June 30, 2003 and June 30, 2004, and the historical consolidated financial statements and related notes thereto of Firstmark for the years ended December 31, 2002 and 2003, included in this prospectus.
The pro forma financial statements are provided for illustrative purposes only and are not necessarily indicative of the operating results or financial position that would have occurred if these transactions had been consummated at the beginning of the period or on the date indicated, nor are they necessarily indicative of any future operating results or financial position. Management believes that the pro forma adjustments are reasonable. We are currently integrating the operations of Firstmark, which will involve additional costs. In addition, as with each of our prior acquisitions, we expect a number of the customer contracts we have acquired in the Firstmark acquisition to expire without renewal. Accordingly, we expect to experience material erosion of the acquired revenue.
23
Unaudited Condensed Pro Forma As Adjusted Balance Sheet
As of June 30, 2004
(dollars in thousands)
|
Cogent Historical |
Adjustments |
Cogent Pro Forma As Adjusted |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 13,000 | $ | 46,750 | (a) | $ | 52,750 | |||||
(7,000 | )(b) | |||||||||||
Short-term investments, $740 restricted | 1,839 | 1,839 | ||||||||||
Accounts receivable, net of allowance for doubtful accounts of $3,109 | 6,754 | 6,754 | ||||||||||
Accounts receivable, related party | 1,214 | 1,214 | ||||||||||
Prepaid expenses and other current assets | 4,434 | 4,434 | ||||||||||
Total current assets |
27,241 |
39,750 |
66,991 |
|||||||||
Property and equipment, net |
346,643 |
346,643 |
||||||||||
Intangible assets, net | 4,227 | 4,227 | ||||||||||
Other assets ($1,333 restricted) | 5,199 | 5,199 | ||||||||||
Total assets | $ | 383,310 | $ | 39,750 | $ | 423,060 | ||||||
Liabilities and stockholders' equity | ||||||||||||
Current liabilities: |
||||||||||||
Accounts payable | $ | 11,036 | $ | 11,036 | ||||||||
Accounts payable related party | 1,322 | 1,322 | ||||||||||
Accrued liabilities | 12,313 | 12,313 | ||||||||||
Current maturities of capital lease obligations | 6,049 | 6,049 | ||||||||||
Total current liabilities |
30,720 |
30,720 |
||||||||||
Long-term liabilities: |
||||||||||||
Capital lease obligations, net of current maturities |
102,464 |
102,464 |
||||||||||
Amended and Restated Cisco Note | 17,842 | (7,347 | )(b) | 10,495 | ||||||||
Convertible notes, net of discount of $5,853 | 4,585 | 4,585 | ||||||||||
Other long term liabilities | 1,621 | 1,621 | ||||||||||
Total liabilities | 157,232 | (7,347 | ) | 149,885 | ||||||||
Stockholders' equity: |
||||||||||||
Convertible preferred stock, Series F | 10,904 | (10,904 | )(c) | | ||||||||
Convertible preferred stock, Series G | 40,787 | (40,787 | )(c) | | ||||||||
Convertible preferred stock, Series H | 41,015 | (41,015 | )(c) | | ||||||||
Convertible preferred stock, Series I | 2,545 | (2,545 | )(c) | | ||||||||
Convertible preferred stock, Series J | 19,421 | (19,421 | )(c) | | ||||||||
Common stock | 1 | (a) | ||||||||||
25 | (c) | |||||||||||
Additional paid-in capital | 235,801 | 114,647 | (c) | |||||||||
(a) | ||||||||||||
Stock purchase warrants | 764 | 764 | ||||||||||
Deferred compensation | (24,955 | ) | (24,955 | ) | ||||||||
Accumulated other comprehensive income | 304 | 304 | ||||||||||
Treasury stock | (90 | ) | (90 | ) | ||||||||
Accumulated deficit | (100,419 | ) | 347 | (b) | (100,072 | ) | ||||||
Total stockholders' equity | $ | 226,078 | ||||||||||
Total liabilities and stockholders' equity | $ | 383,310 | ||||||||||
24
Unaudited Condensed Pro Forma Statement of Operations
For the Year Ended December 31, 2003
(in thousands, except share and per share data)
|
Historical Cogent |
Historical Firstmark |
Acquisition Adjustments |
Offering Adjustments |
Pro Forma As Adjusted |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net service revenue | $ | 59,422 | $ | 24,423 | $ | $ | 83,845 | ||||||||
Revenue with affiliated companies | | 2,108 | 2,108 | ||||||||||||
Total service revenue | 59,422 | 26,531 | 85,953 | ||||||||||||
Operating expenses: |
|||||||||||||||
Cost of network services, exclusive of amounts shown separately | 48,324 | 5,026 | 53,350 | ||||||||||||
Cost of revenue from affiliated companies | | 7,867 | 7,867 | ||||||||||||
Selling, general & administrative | 43,938 | 22,149 | 66,087 | ||||||||||||
Impairment and loss on assets | | 3,279 | 3,279 | ||||||||||||
Depreciation & amortization | 48,387 | 16,764 | (9,316 | )(d) | 55,835 | ||||||||||
Total operating expenses | 140,649 | 55,085 | 186,418 | ||||||||||||
Operating loss |
(81,227 |
) |
(28,554 |
) |
(100,465 |
) |
|||||||||
Gains on debt extinguishments | 240,234 | 105,283 | 345,517 | ||||||||||||
Interest expense | (19,776 | ) | (8,309 | ) | (28,085 | ) | |||||||||
Interest income and other | 1,512 | 80 | 1,592 | ||||||||||||
Net income before cumulative effect of accounting change |
140,743 | 68,500 | 218,559 | ||||||||||||
Cumulative effect on prior years of applying SFAS 143 | | (289 | ) | (289 | ) | ||||||||||
Net income | $ | 140,743 | $ | 68,211 | $ | 218,270 | |||||||||
Beneficial conversion charge | (52,000 | ) | | (2,575 | )(e) | (54,575 | ) | ||||||||
Net income available to common shareholders | $ | 88,743 | $ | 68,211 | $ | 163,695 | |||||||||
Earnings Per Share |
|||||||||||||||
Basic net income per common share | $ | 363.47 | |||||||||||||
Beneficial conversion charge | (134.29 | ) | |||||||||||||
Basic net income per common share available to common shareholders | $ | 229.18 | |||||||||||||
Diluted net income per common share | $ | 17.73 | |||||||||||||
Beneficial conversion charge | (6.55 | ) | |||||||||||||
Diluted net income per common share available to common shareholders | $ | 11.18 | |||||||||||||
Weighted average common shares basic | 387,218 | 26,131,576 | (h) | ||||||||||||
(g) | |||||||||||||||
Weighted average common shares diluted | 7,938,898 | 798,129 | (f) | 17,784,813 | (h) | ||||||||||
(g) |
25
Notes to the Unaudited Condensed Pro Forma Financial Statements
(a) Represents the estimated net proceeds of $46.8 million from the sale of million shares of our common stock for $ per share.
(b) Represents the repayment of $7.0 million of our aggregate of $17.0 million indebtedness to Cisco with a portion of the proceeds from this offering and the resulting gain of $0.3 million. The gain of approximately $0.3 million has not been reflected in our pro forma statement of operations as it is a one time event in connection with the offering.
(c) Represents the impact of the conversion of our Series F, Series G, Series H, Series I and Series J preferred stock into 24,913,889 shares of common stock after the Reverse Stock Split effected prior to this offering.
(d) Represents the reduction to depreciation and amortization expense of approximately $9.5 million from the allocation of negative goodwill to property and equipment and intangible assets and the increase to amortization expense of $0.2 million from the amortization of acquired intangible assets. Acquired intangibles include customer contracts and will be amortized over their estimated useful lives of two years. The purchase price of Firstmark was approximately $78.9 million which includes the fair value of our Series I preferred stock of $2.6 million and assumed liabilities of $76.3 million. The fair value of assets acquired was approximately $155.5 million which then gave rise to negative goodwill of approximately $76.6 million. Negative goodwill was allocated to long-lived assets, resulting in recorded assets acquired of $78.9 million. As a result, acquired long-lived assets from Firstmark were recorded at less than their historical net book value.
(e) Represents the beneficial conversion charge of $2.6 million recorded since the conversion prices on the Series I preferred stock at issuance is less than the trading price of our common stock on that date.
(f) Represents the increase in fully diluted shares outstanding due to the issuance of the Series I preferred stock. Our Series I preferred stock is convertible into 798,129 shares of our common stock.
(g) Represents the impact on our basic and fully diluted weighted average common shares due to the issuance of million shares of our common stock for $ per share.
(h) Represents the impact of the conversion of our Series F, Series G, Series H, Series I, Series J, Series K and Series L preferred shares into common shares.
Reflected below is the impact of the Equity Conversion and offering on our per share net loss for the six months ended June 30, 2004.
Pro Forma Per-Share Information |
Six months ended June 30, 2004 |
||
---|---|---|---|
Basic and diluted net loss applicable to common stock |
$(95.99 |
) |
|
Basic and diluted weighted average common shares outstanding |
712,794 |
||
Pro forma as adjusted basic and diluted net loss per common share |
|||
Pro forma as adjusted basic and diluted weighted average common shares outstanding |
26
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following table sets forth our selected historical consolidated financial data for the periods indicated. We derived the selected consolidated financial data presented below as of December 31, 2003 and for each of the four years then ended and the period from August 9, 1999 to December 31, 1999 from our audited consolidated financial statements. We were incorporated on August 9, 1999, accordingly, no financial information prior to August 9, 1999 is available. We derived our consolidated statement of operations data presented below for the years ended December 31, 2003 and 2002, and our balance sheet data as of December 31, 2003 and 2002 from our consolidated financial statements, which were audited by Ernst & Young LLP, our independent auditors. We derived our consolidated statement of operations data presented below for the years ended December 31, 2001, 2000 and for the period from August 9, 1999 to December 31, 1999 and our balance sheet data as of December 31, 2001, 2000 and 1999 from our consolidated financial statements, which were audited by Arthur Andersen LLP, our independent auditor during those periods. We derived the selected financial data as of and for the six months ended June 30, 2004 and 2003 from our unaudited consolidated interim financial statements included elsewhere in this prospectus. In our opinion, the unaudited consolidated interim financial statements have been prepared on a basis consistent with the audited financial statements and include all adjustments, which are normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations for the unaudited periods presented.
The period-to-period comparability of our historical results is materially affected by several significant acquisitions. These acquisitions and their effect on our business are described in "Management's Discussion and Analysis of Financial Condition and Results of OperationsAcquisitions." Partly as a result of the impact of these acquisitions, our historical results are not necessarily indicative of future operating results. You should read the information set forth below in conjunction with "Unaudited Condensed Pro Forma Financial Information," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes included elsewhere in this prospectus.
|
|
|
|
|
|
Six Months Ended June 30, |
|||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
August 9, 1999 to December 31, 1999 |
Year Ended December 31, |
|||||||||||||||||||||||
|
2000 |
2001 |
2002 |
2003 |
2003 |
2004 |
|||||||||||||||||||
|
|
|
|
|
|
(unaudited) |
|||||||||||||||||||
|
(in thousands, except share and per share data) |
||||||||||||||||||||||||
Statement of Operations Data: | |||||||||||||||||||||||||
Net service revenue | $ | | $ | | $ | 3,018 | $ | 51,913 | $ | 59,422 | $ | 29,751 | $ | 41,332 | |||||||||||
Operating expenses: | |||||||||||||||||||||||||
Cost of network operations | | 3,040 | 19,990 | 49,091 | 47,017 | 22,913 | 29,008 | ||||||||||||||||||
Amortization of deferred compensation cost of network operations | | | 307 | 233 | 1,307 | 108 | 425 | ||||||||||||||||||
Selling, general, and administrative | 82 | 10,845 | 27,322 | 33,495 | 26,570 | 13,702 | 19,119 | ||||||||||||||||||
Amortization of deferred compensation selling, general and administrative | | | 2,958 | 3,098 | 17,368 | 1,440 | 5,652 | ||||||||||||||||||
Gain on settlement of vendor litigation | | | | (5,721 | ) | | | | |||||||||||||||||
Depreciation and amortization | | 338 | 13,535 | 33,990 | 48,387 | 23,038 | 28,285 | ||||||||||||||||||
Total operating expenses | 82 | 14,223 | 64,112 | 114,186 | 140,649 | 61,201 | 82,489 | ||||||||||||||||||
Operating loss | (82 | ) | (14,223 | ) | (61,094 | ) | (62,273 | ) | (81,227 | ) | (31,450 | ) | (41,157 | ) | |||||||||||
Gain-Allied Riser note exchange | | | | | 24,802 | 24,802 | | ||||||||||||||||||
Gain-Cisco debt restructuring | | | | | 215,432 | | | ||||||||||||||||||
Settlement of noteholder litigation | | | | (3,468 | ) | | | | |||||||||||||||||
Interest income (expense) and other, net | | 2,462 | (5,819 | ) | (34,545 | ) | (18,264 | ) | (14,234 | ) | (5,238 | ) | |||||||||||||
(Loss) income before extraordinary item | $ | (82 | ) | $ | (11,761 | ) | $ | (66,913 | ) | $ | (100,286 | ) | $ | 140,743 | $ | (20,882 | ) | $ | (46,395 | ) | |||||
Extraordinary gain Allied Riser merger | | | | 8,443 | | | | ||||||||||||||||||
Net (loss) income | $ | (82 | ) | $ | (11,761 | ) | $ | (66,913 | ) | $ | (91,843 | ) | $ | 140,743 | $ | (20,882 | ) | $ | (46,395 | ) | |||||
Beneficial conversion of preferred stock | $ | | $ | | $ | (24,168 | ) | $ | | $ | (52,000 | ) | $ | | $ | (22,028 | ) | ||||||||
Net (loss) income applicable to common stock | $ | (82 | ) | $ | (11,761 | ) | $ | (91,081 | ) | $ | (91,843 | ) | $ | 88,743 | $ | (20,882 | ) | $ | (68,423 | ) | |||||
Net (loss) income per common share: | |||||||||||||||||||||||||
Basic | $ | (1.21 | ) | $ | (170.16 | ) | $ | (951.82 | ) | $ | (564.45 | ) | $ | 363.47 | $ | (119.88 | ) | $ | (95.99 | ) | |||||
Diluted | $ | (1.21 | ) | $ | (170.16 | ) | $ | (951.82 | ) | $ | (564.45 | ) | $ | 17.73 | $ | (119.88 | ) | $ | (95.99 | ) | |||||
Weighted-average common shares: | |||||||||||||||||||||||||
Basic | 68,000 | 69,118 | 70,300 | 162,712 | 387,218 | 174,192 | 712,794 | ||||||||||||||||||
Diluted | 68,000 | 69,118 | 70,300 | 162,712 | 7,938,898 | 174,192 | 712,794 | ||||||||||||||||||
27
|
August 9, 1999 to December 31, 1999 |
As of and for the Year Ended December 31, |
As of and for the Six Months Ended June 30, |
|||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2003 |
2003 |
2004 |
||||||||||||||||
|
|
|
|
|
|
(unaudited) |
||||||||||||||||
|
(dollars in thousands) |
|||||||||||||||||||||
Operating Data (unaudited): | ||||||||||||||||||||||
On-net revenue | | | 59.7 | % | 31.9 | % | 55.6 | % | 53.1 | % | 65.6 | % | ||||||||||
Off-net revenue | | | 40.3 | % | 40.7 | % | 26.4 | % | 26.1 | % | 22.3 | % | ||||||||||
Non-core revenue | | | | 27.4 | % | 18.0 | % | 20.8 | % | 12.1 | % | |||||||||||
On-net customer connections |
|
|
189 |
881 |
1,649 |
1,032 |
2,258 |
|||||||||||||||
On-net buildings | | | 127 | 511 | 813 | 719 | 926 | |||||||||||||||
Other Financial Data: |
||||||||||||||||||||||
Capital expenditures | $ | | $ | 80,989 | $ | 118,020 | $ | 75,214 | $ | 24,016 | $ | 18,297 | $ | 4,038 | ||||||||
Net cash used in operating activities | (75 | ) | (16,370 | ) | (46,786 | ) | (41,567 | ) | (27,357 | ) | (18,763 | ) | (17,629 | ) | ||||||||
Net cash (used in) provided by investing activities | | (80,989 | ) | (131,652 | ) | (19,786 | ) | (25,316 | ) | (16,258 | ) | 26,480 | ||||||||||
Net cash provided by (used in) financing activities | 75 | 162,952 | 161,862 | 51,694 | 20,562 | 1,398 | (3,308 | ) | ||||||||||||||
|
As of December 31, |
As of June 30, |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
1999 |
2000 |
2001 |
2002 |
2003 |
2003 |
2004 |
|||||||||||||||
|
(in thousands) |
(unaudited) |
||||||||||||||||||||
Balance Sheet Data: | ||||||||||||||||||||||
Cash, cash equivalents and short-term investments | $ | | $ | 65,593 | $ | 50,763 | $ | 42,829 | $ | 11,990 | $ | 7,031 | $ | 14,839 | ||||||||
Working capital (deficit) | 17 | 52,621 | 46,579 | (229,056 | ) | (866 | ) | (271,633 | ) | (3,479 | ) | |||||||||||
Property and equipment, net | | 111,653 | 235,782 | 322,780 | 314,406 | 326,514 | 346,643 | |||||||||||||||
Total assets | 25 | 187,740 | 319,769 | 407,677 | 344,440 | 371,827 | 383,310 | |||||||||||||||
Capital lease obligations | | 10,697 | 21,158 | 58,785 | 61,753 | 61,077 | 108,513 | |||||||||||||||
Notes payable (net of discount) | | 67,239 | 181,312 | 289,145 | 21,949 | 266,523 | 22,427 | |||||||||||||||
Convertible preferred stock | | 115,901 | 177,246 | 175,246 | 97,681 | 183,755 | 114,672 | |||||||||||||||
Stockholders' equity | 18 | 104,248 | 110,214 | 32,626 | 244,754 | 22,451 | 226,078 |
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis together with "Selected Consolidated Financial and Other Data" and our consolidated financial statements and related notes included in this prospectus. The discussion in this prospectus contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this prospectus should be read as applying to all related forward-looking statements wherever they appear in this prospectus. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to these differences include those discussed in "Risk Factors," as well as those discussed elsewhere. You should read "Risk Factors" and "Cautionary Notice Regarding Forward-Looking Statements."
General Overview
We are a leading facilities-based provider of low-cost, high-speed Internet access and IP connectivity. Our network has been designed and optimized to transmit data using Internet Protocol, which provides us with significant cost and performance advantages over legacy networks. We deliver our services to more than 5,000 small and medium-sized businesses, communications service providers, and other bandwidth-intensive organizations located in North America and Europe. Our primary service is providing Internet access at a speed of 100 Megabits per second, much faster than typical Internet access currently offered to businesses and is delivered through our own facilities running 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 intercity transport facilities. The network is physically connected entirely through our facilities to over 950 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 colocation facilities, data centers and single-tenant office buildings. Because of our network architecture, we are not dependent on local telephone companies to serve our on-net customers. In addition to providing our on-net services, we also provide Internet connectivity to customers that are not located in buildings directly connected to our network. 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 emphasize the sale of on-net services because sales of these services generate higher gross profit margins. For the six months ended June 30, 2003, 53.1% of our net service revenue was generated from on-net customers as compared to 65.6% in the same period in 2004.
We believe our key opportunity is provided by our network. We currently serve an average of approximately 4% of the tenants in each of our multi-tenant on-net buildings. This provides us with the opportunity to add a significant number of customers to our network with limited incremental costs. Our greatest challenge is adding customers to our network in a way that maximizes its use and at the same time provides us with a customer mix that produces strong profit margins. We are responding to this opportunity and challenge by increasing our sales and marketing efforts. We expect to use a portion of the proceeds of this offering to expand our sales and marketing efforts. The amount and timing of these expenditures will be dependent on the progress and success of these efforts.
Expansion of our network will be directed to locations that can be economically integrated into our fiber optic network and represent significant concentrations of Internet traffic. We believe that the relative maturities of our North American and European operations will result in the majority of this expansion occurring in Europe. We may identify locations that we desire to serve with our on-net product but cannot be cost effectively added to our network. The key 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 those customers.
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The delivery of Internet access services remains very competitive and we will continue to focus our sales and marketing efforts on the services that leverage our network. We will not focus on our non-core products because, even though profitable, they do not utilize our network as effectively as the on-net and off-net Internet access services we actively market.
We believe the two most important trends in our industry are the continued growth in Internet traffic and a corresponding continuing 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 leverage 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 our results of operations.
We have grown our net service revenue from $3.0 million for the year ended December 31, 2001 to $59.4 million for the year ended December 31, 2003 and from $29.8 million for the six months ended June 30, 2003 to $41.3 million for the six months ended June 30, 2004. Net service revenue is determined by subtracting our allowances for sales credit adjustments and unfulfilled purchase obligations from our gross service revenue.
We have generated our growth through the strategic acquisitions of communications network assets, primarily from financially distressed companies, and the continued expansion of our network of on-net buildings. Our results for the year ended December 31, 2003 do not include the impact of our four most recent acquisitions that extended our business into Europe and expanded our customer base and service offerings in North America. The acquisition of Firstmark Communications Participation S.à r.l., or Firstmark, on January 5, 2004 extended our network into France, Spain, the United Kingdom, Belgium, Switzerland and the Netherlands. On March 30, 2004, we obtained rights to approximately 1,500 fiber route miles and other assets that were once part of the Carrier 1 International S.A. network in Germany.
We are integrating these network assets into our network and are expanding our current on-net service offerings into Europe. As with prior acquisitions, we plan to continue to support a number of legacy service offerings in Europe, but will focus our efforts on selling our on-net IP data service offerings. On August 12, 2004, we acquired the majority of the assets of Unlimited Fiber Optics, Inc., or UFO. Among these assets were UFO's customer base, which is comprised of data service customers and its network, which is comprised of fiber optic facilities located in San Francisco, Los Angeles and Chicago. On September 15, 2004, we acquired the majority of the assets of Global Access Telecommunications Inc., or Global Access. Global Access is located in Frankfurt Germany and provides Internet access, and other value added services.
Our net service revenue is derived from our on-net, off-net and non-core services, which comprised 53.1%, 26.1% and 20.8% of our net revenue, respectively, for the six months ended June 30, 2003 and 65.6%, 22.3% and 12.1% for the six months ended June 30, 2004. Our on-net service consists of high-speed Internet access and Internet Protocol connectivity ranging from 0.5 Mbps per second to 1,000 Mbps per second of bandwidth. We offer our on-net services to customers located in buildings that are physically connected to our network. Off-net services are sold to businesses that are connected to our network by means of T1 and T3 lines obtained from other carriers. Our non-core services, which consist of legacy services of companies whose assets or businesses we have acquired, include email, dial-up Internet, shared web hosting, managed web hosting, managed security, and voice services provided in Toronto, Canada only. We do not actively market these non-core services and expect the revenue associated with them to decline.
In connection with each of our acquisitions in which we have acquired customer contracts, some portion of these customers have elected not to continue purchasing services from us. Accordingly, historical operating results from the acquired businesses or assets have not been indicative of our combined results. As discussed in "Management's Discussion and Analysis of Financial Condition and
30
Results of OperationsAcquisitions," our evaluation of potential acquisitions contemplates such patterns of revenue erosion.
We have grown our gross profit from a negative $17.0 million for the year ended December 31, 2001 to $12.4 million for the year ended December 31, 2003 and from $6.8 million for the six months ended June 30, 2003 to $12.3 million for the six months ended June 30, 2004. Our gross profit margin has expanded from 21% in 2003 to 30% for the six months ended June 30, 2004. We determine gross profit by subtracting network operation expenses (exclusive of amounts shown separately), other than amortized deferred compensation, from our net service revenue. The amortization of deferred compensation classified as cost of network services was $0.3 million, $0.2 million and $1.3 million for the years ended December 31, 2001, 2002 and 2003, respectively, and $0.1 million and $0.4 million for the six months ended June 30, 2003 and 2004, respectively. We believe that our gross profit will benefit from the limited incremental expenses associated with providing service to new on-net customers. 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 without incurring significant additional capital expense. As a result, our future capital expenditures will be based primarily on our planned expansion of on-net buildings and the growth of our customer base. We currently intend to expand our on-net buildings by 7%, primarily in Europe, over the next 12 months. Accordingly, we anticipate that our future capital expenditure rate will be significantly less than our historical capital expenditure rate.
Historically, our operating expenses have exceeded our net service revenue resulting in operating losses of $61.1 million, $62.3 million and $81.2 million in 2001, 2002 and 2003, respectively, and $31.5 million and $41.2 million in the first six months of 2003 and 2004, respectively. In each of these periods, our operating expenses consisted primarily of the following:
We anticipate significant additional deferred compensation expenses in the future based on our board of directors' recent approval of additional option grants. In May 2004, our board of directors authorized the grant of stock options exercisable for the purchase of shares of our Series H preferred stock, or approximately 1.0 million shares of common stock after giving effect to the Equity Conversion. These grants were made in September 2004 and certain of these grants will result in additional deferred compensation expense. We will begin amortizing these expenses in the third quarter of 2005.
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Acquisitions
Since our inception, we have consummated eight major and three minor acquisitions through which we have 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 both North America and 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. Net service revenue generated by the customer contracts that we have acquired has accounted for a substantial portion of our historical growth in net service revenue. However, historically we have experienced, and expect to continue to experience, material erosion of revenue generated by these acquired customer contracts. Our recent operating results are illustrative of this trend as net service revenue attributable to customer contracts acquired in each of the PSINet, FNSI, and Firstmark acquisitions declined during the three months ended June 30, 2004 compared to the prior three-months period as set forth in the following table:
Customer Contracts |
Three months ended June 30, 2004 |
Three months ended March 31, 2004 |
Percentage decline |
||||||
---|---|---|---|---|---|---|---|---|---|
PSINet | $ | 1,770 | $ | 1,895 | (7.0 | )% | |||
FNSI | 725 | 937 | (29.2 | )% | |||||
Firstmark | 5,010 | 5,586 | (11.5 | )% |
Acquisition of UFO Group, Inc.
On August 12, 2004, our wholly owned subsidiary, Marvin Internet, Inc., merged with UFO Group, Inc. We issued shares of our preferred stock in exchange for the outstanding shares of UFO Group. The preferred stock issued in the merger will convert into approximately 0.8 million shares of our common stock immediately prior to this offering. Prior to the merger, UFO Group had acquired the majority of the assets of Unlimited Fiber Optics, Inc., or UFO. Among these assets were UFO's customer base, which is comprised of data service customers and its network, which is comprised of fiber optic facilities located in San Francisco, Los Angeles and Chicago. The acquired assets included net cash of approximately $2.0 million, all of UFO's customer contracts (which generated approximately $0.4 million in revenue during July 2004), customer accounts receivable and certain network equipment. Assumed liabilities include certain vendor relationships and accounts payable. We intend to integrate these acquired assets into our operations and onto our broadband network.
Acquisition of European Network
We expanded our network into Europe through a number of related transactions. In September 2003, we began exploring the possibility of acquiring LNG Holdings SA, 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 existing investors regarding the acquisition of the LNG network in France, Spain and Germany.
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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, the parent holding company of LambdaNet France and LambdaNet Spain, from LNG for one euro. 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 preferred stock that will convert into approximately 0.8 million shares of our common stock immediately prior to this offering.
The planned second step of the transaction was the acquisition of the German network of LNG. We attempted to structure an acceptable acquisition which would have included 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 the Carrier 1 assets in return for 2.3 million euros. That corporation then was merged into one of our subsidiaries in a transaction in which the investors received preferred stock which will convert into approximately 6.0 million shares of our common stock immediately prior to this offering.
On September 15, 2004, we expanded our European network by acquiring the majority of the assets of Global Access Telecommunications Inc., or Global Access. In the transaction, we issued shares of our preferred stock in exchange for these assets. The preferred stock issued in the transaction will convert into approximately 0.3 million shares of our common stock immediately prior to this offering. Global Access is located in Frankfurt, Germany and provides Internet access and other services. The acquired assets included all of Global Access' customer contracts (which generated approximately $0.4 million in revenue in August 2004), customer accounts receivable and certain network equipment. Assumed liabilities include certain vendor relationships, employee contracts, and accounts payable. We intend to integrate these acquired assets into our operations and onto our broadband network.
Acquisition of Assets of Fiber Network Services
In February 2003, we acquired the principal 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. The acquired assets included FNSI's customer contracts and accounts receivable. The liabilities that we assumed included accounts payable, facilities leases, customer contractual commitments, capital lease and note obligations.
Acquisition of PSINet Assets
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. The assets included certain of PSINet's accounts receivable, rights to approximately 10,000 route miles of dark fiber pursuant to IRUs, and intangible assets including settlement-free peering agreements, customer contracts and the PSINet trade name. The liabilities that we assumed included leased circuit commitments, facilities leases, customer contractual commitments and colocation arrangements. With the acquisition of PSINet assets we began to offer our off-net service and acquired significant non-core services.
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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 approximately 100,000 shares of our common stock. As a result of the merger, Allied Riser became a wholly-owned subsidiary of ours. In connection with the merger, we became co-obligor under Allied Riser's 71/2% Convertible Subordinated Notes Due 2007.
Acquisition of NetRail Assets
In September 2001, we purchased for $11.7 million the principal assets of NetRail, Inc. out of bankruptcy. The assets included certain customer contracts and the related accounts receivable, circuits, network equipment, and settlement-free peering agreements with Tier-1 Internet service providers.
Results of Operations
Our management reviews and analyzes several key performance indicators in order to manage our business and assess the quality of and potential variability of our net service revenues and cash flows. These key performance indicators include:
Six Months Ended June 30, 2003 Compared to the Six Months Ended June 30, 2004
The following summary table presents a comparison of our results of operations for the six months ended June 30, 2003 and 2004 with respect to certain key financial measures. The comparisons illustrated in the table are discussed in greater detail below.
|
Six Months Ended June 30, |
|
|||||||
---|---|---|---|---|---|---|---|---|---|
|
Percent Change |
||||||||
|
2003 |
2004 |
|||||||
|
(unaudited) |
|
|||||||
|
(in thousands) |
|
|||||||
Net service revenue | $ | 29,751 | $ | 41,332 | 38.9 | % | |||
Network operations expenses (1) | 22,913 | 29,008 | 26.6 | % | |||||
Selling, general, and administrative expenses (2) | 13,702 | 19,119 | 39.5 | % | |||||
Depreciation and amortization expenses | 23,038 | 28,285 | 22.8 | % | |||||
Gain on Allied Riser note exchange | 24,802 | | | ||||||
Interest expense | (14,944 | ) | (6,370 | ) | (57.4 | )% | |||
Net loss | (20,822 | ) | (46,395 | ) | 122.8 | % |
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Net Service Revenue. Our net service revenue increased 38.9% from $29.8 million for the six months ended June 30, 2003 to $41.3 million for the six months ending June 30, 2004. The increase in net service revenue is primarily attributable to $10.6 million of net service revenue from the customers acquired in the January 5, 2004, Firstmark acquisition and a $7.7 million increase in organic revenue, or revenue derived from contracts that have resulted from our sales efforts. These increases were partially offset by a $6.2 million decrease in revenue from the customers acquired in the PSINet acquisition. For the six months ended June 30, 2003 and 2004, on-net, off-net and non-core services represented 53.1%, 26.1% and 20.8% and 65.6%, 22.3% and 12.1% of our net service revenues, respectively.
Our net service revenue related to our acquisitions is included in our statements of operations from the acquisition dates. Net service revenue from our Firstmark acquisition totaled approximately $10.6 million for the six months ended June 30, 2004. Approximately $1.1 million of the Firstmark net service revenue was derived from 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. We are in the process of renegotiating LambdaNet Germany's service contracts and may lose some or all of this revenue. Additionally we expect to experience material erosion of revenues generated by Firstmark as certain Firstmark customers have indicated to us that they will not continue to purchase, or will reduce their purchases of, Firstmark's services after the expiration of their current contractual obligations. In 2003, revenue under contracts with these customers represented approximately 3.8 million euros of Firstmark's total revenue of 23.5 million euros. Net service revenue from the acquired PSINet legacy customer contracts totaled approximately $9.9 million for the six months ended June 30, 2003 and $3.7 million for the six months ended June 30, 2004. Net service revenue from our FNSI acquisition totaled approximately $1.7 million for the six months ended June 30, 2003 and $1.7 million for the six months ended June 30, 2004.
Network Operations Expenses. Our network operations expenses, excluding the amortization of deferred compensation, increased 26.6% from $22.9 million for the six months ended June 30, 2003 to $29.0 million for the six months ended June 30, 2004. The increase is primarily attributable to $7.5 million of costs incurred in connection with the operation of our European network after the Firstmark acquisition. The increase was partly offset by a $1.3 million reduction in leased circuit and maintenance expenses resulting primarily from a reduction in the number of off-net PSINet customers. For the six month period ended June 30, 2004, Firstmark recorded $1.4 million of network usage costs from LambdaNet Germany. We are in the process of renegotiating the LambdaNet Germany service contracts. Our total cost of network operations for the six months ended June 30, 2003 and June 30, 2004 includes approximately $0.1 million and $0.4 million, respectively, of amortization of deferred compensation expense classified as cost of network operations.
Selling, General, and Administrative Expenses. Our SG&A expenses, excluding the amortization of deferred compensation, increased 39.5% from $13.7 million for the six months ended June 30, 2003 to $19.1 million for the six months ended June 30, 2004. SG&A expenses increased primarily from the $5.2 million of SG&A expenses associated with our operations in Europe after our Firstmark acquisition. Our SG&A expenses for the six month period ended June 30, 2004 includes a $0.6 million expense related to the settlement of a dispute with a landlord over a lease acquired in the Allied Riser merger. Our total SG&A expenses for the six months ended June 30, 2003 and June 30, 2004 include $1.4 million and $5.7 million, respectively, of amortization of deferred compensation expense.
Amortization of Deferred Compensation. The amortization of deferred compensation increased from $1.5 million for the six months ended June 30, 2003 to $6.1 million for the six months ending June 30, 2004. The increase is attributed to the amortization of deferred compensation related to restricted shares of Series H preferred stock granted to our employees primarily in October 2003 under our 2003 Incentive Award Plan.
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Depreciation and Amortization Expenses. Our depreciation and amortization expense increased 22.8% from $23.0 million for the six months ended June 30, 2003 to $28.3 million for the six months ended June 30, 2004. Of this increase, $3.4 million resulted from depreciation and amortization of assets acquired in our Firstmark acquisition. Additionally, we had more capital equipment and IRUs in service in 2004 than in the same period in 2003. We begin to depreciate our capital assets once the related assets are placed in service.
Interest Expense. Our interest expense decreased 57.4% from $14.9 million for the six months ended June 30, 2003 to $6.4 million for the six months ended June 30, 2004. Interest expense for the six months ended June 30, 2004, includes interest from our capital lease agreements and our 71/2% Convertible Subordinated Notes Due 2007. Interest expense for the six months ended June 30, 2003 also included interest on our Cisco credit facility and the amortization of the related deferred financing costs. The decrease in interest expense resulted from the March 2003 settlement with the Allied Riser noteholders and the restructuring of our Cisco credit facility in July 2003. Our Cisco credit facility debt restructuring 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. As a result, we did not record interest expense under the Amended and Restated Cisco Note for the six month period ended June 30, 2004.
Gain on Allied Riser Note Exchange. In connection with the exchange and settlement related to our 71/2% Convertible Subordinated Notes Due 2007 we recorded a gain of approximately $24.8 million during the six months ended June 30, 2003. This gain results 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, the cash consideration of $5.0 million and the $8.5 million estimated fair market value for the Series D and Series E preferred stock issued to the noteholders 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 our Series C preferred stock which represented our most recent equity transaction for cash.
Net Income Loss. As a result of the foregoing, net loss was $20.8 million for the six months ended June 30, 2003 as compared to a net loss of $46.4 million for the six months ended June 30, 2004.
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Year Ended December 31, 2002 Compared to the Year Ended December 31, 2003
The following summary table presents a comparison of our results of operations for the years ended December 31, 2002 and 2003 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 |
||||||
|
(in thousands) |
|
||||||
Net service revenue | $ | 51,913 | $ | 59,422 | 14.5% | |||
Network operations expenses (1) | 49,091 | 47,017 | (4.2)% | |||||
Selling, general, and administrative expenses (2) | 33,495 | 26,570 | (20.7)% | |||||
Depreciation and amortization expenses | 33,990 | 48,387 | 42.4% | |||||
Interest income and other | 1,739 | 1,512 | (13.1)% | |||||
Interest expense | (36,284 | ) | (19,776 | ) | (45.5)% | |||
Net (loss) income | (91,843 | ) | 140,743 | N/A |
Net Service Revenue. Our net service revenue increased 14.5% from $51.9 million for the year ended December 31, 2002 to $59.4 million for the year ended December 31, 2003. This increase was primarily attributable to a $16.5 million, or a 99.5% increase in revenue from a 87.2% increase in customers purchasing our on-net Internet access service offerings, and a $6.6 million increase in off-net revenue attributable to the customers acquired in the FNSI acquisition. FNSI revenue is included in our consolidated net service revenue since the closing of the acquisition on February 28, 2003. The increase was partially offset by a $15.5 million, or 50.9% decline in net service revenue derived from customers acquired in our April 2, 2002 acquisition of certain PSINet customer accounts.
Network Operations Expenses. Our network operations expenses, excluding the amortization of deferred compensation, decreased 4.2% from $49.1 million for the year ended December 31, 2002 to $47.0 million for the year ended December 31, 2003. This decrease was primarily due to a $2.0 million decrease during the year ended December 31, 2003 in recurring and transitional PSINet circuit fees associated with providing our off-net services compared to the year ended December 31, 2002. This decrease in circuit fees was primarily driven by a reduction in the number of off-net customers that we served during 2003 and the termination of the transitional fees related to the PSINet acquisition.
Selling, General, and Administrative Expenses. Our SG&A expenses, excluding the amortization of deferred compensation, decreased 20.7% from $33.5 million for the year ended December 31, 2002 to $26.6 million for the year ended December 31, 2003. SG&A for the years ended December 31, 2002 and December 31, 2003 included approximately $3.2 million and $3.9 million, respectively, of expenses related to our allowance for uncollectable accounts. The decrease in SG&A expenses was due to a reduction in transitional activities associated with the Allied Riser, PSINet and FNSI acquisitions and a decrease in headcount during 2003 as compared to 2002.
Amortization of Deferred Compensation. The amortization of deferred compensation increased from $3.3 million for the year ended December 31, 2002 to $18.7 million for the year ending December 31, 2003. The increase is attributed to the amortization of deferred compensation related to
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restricted shares of Series H preferred stock granted to our employees primarily in October 2003 under our 2003 Incentive Award Plan.
Depreciation and Amortization Expenses. Our depreciation and amortization expenses increased 42.4% from $34.0 million for the year ended December 31, 2002 to $48.4 million for the year ended December 31, 2003. This increase occurred primarily because we had more capital equipment and IRUs in service in 2003 than in the 2002. The increase was also attributable to an increase in amortization expense in the 2003 period over 2002. Amortization expense increased because we had more intangible assets during 2003 than in 2002.
Interest Income and Other. Our interest income decreased by 13.1% from $1.7 million for the year ended December 31, 2002 to $1.5 million for the year ended December 31, 2003, resulting from a decrease in marketable securities and a reduction in interest rates.
Interest Expense. Our interest expense decreased by 45.5% from $36.3 million for the year ended December 31, 2002 to $19.8 million for the year ended December 31, 2003, resulting primarily from (1) the closing of the Allied Riser note settlement and exchange during the first quarter of 2003 and the related cancellation of $106.7 million in principal amount of our 71/2% Convertible Subordinated Notes Due 2007 under the 2003 settlement and exchange, (2) the July 31, 2003 restructuring of our previous Cisco credit facility, 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.
Settlement of Allied Riser Noteholder Litigation and Gain on Note Exchange. In connection with the note exchange and settlement that is discussed in greater detail below in "Liquidity and Capital Resources," we recorded a gain of approximately $24.8 million recorded during the year ended December 31, 2003. The gain resulted from the difference between the $36.5 million net book value of the notes ($106.7 million face value less an unamortized discount of $70.2 million) and $2.0 million of accrued interest and the 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 noteholders less approximately $0.2 million of transaction costs.
GainCisco Recapitalization. The restructuring of our previous Cisco credit facility on July 31, 2003 resulted in a gain of approximately $215.4 million. On a basic income and diluted income per share basis the gain was $556.36 and $27.14 for the year ended December 31, 2003, respectively. The gain resulted from the retirement of the amounts outstanding under the previous 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 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 | ||
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Net (Loss) Income. As a result of the foregoing, we incurred a net (loss) of $(91.8) million for the year ended December 31, 2002 and net income of $140.7 million for the year ended December 31, 2003.
Year Ended December 31, 2001 Compared to the Year Ended December 31, 2002
The following summary table presents a comparison of our results of operations for the years ended December 31, 2001 and 2002 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 |
|||||||
|
2001 |
2002 |
||||||
|
(in thousands) |
|
||||||
Net service revenue | $ | 3,018 | $ | 51,913 | 1,620.1% | |||
Network operations expenses (1) | 19,990 | 49,091 | 145.6% | |||||
Selling, general, and administrative expenses (2) | 27,322 | 33,495 | 22.5% | |||||
Depreciation and amortization expenses | 13,535 | 33,990 | 151.1% | |||||
Interest income and other | 2,126 | 1,739 | (18.2)% | |||||
Interest expense | (7,945 | ) | (36,284 | ) | 356.7% | |||
Net loss | (66,913 | ) | (91,843 | ) | 37.3% |
Net Service Revenue. Our net service revenue increased 1,620.1% from $3.0 million for the year ended December 31, 2001 to $51.9 million for the year ended December 31, 2002. This increase was primarily attributable to an increase in our customers purchasing our service offerings from 210 customers at December 31, 2001 to approximately 4,200 customers at December 31, 2002, including customers acquired in our Allied Riser merger and our PSINet acquisition.
Network Operations Expenses. Our network operations expenses increased 145.6% from $20.0 million for the year ended December 31, 2001 to $49.1 million for the year ended December 31, 2002. This increase was primarily due to an increase during 2002 of approximately $16.2 million of circuit and transition fees primarily related to the PSINet customers acquired, an increase of approximately $2.1 million in maintenance fees on our IRUs and network equipment, and an increase of approximately $3.0 million in fees from an increase in the number of telecommunications license agreements, including the telecommunications license agreements acquired in the February 2002 Allied Riser merger. This increase was partially offset by the elimination of temporary leased transmission capacity charges of $1.3 million in 2002.
Selling, General, and Administrative Expenses. Our SG&A expenses increased 22.5% from $27.3 million for the year ended December 31, 2001 to $33.5 million for the year ended December 31, 2002. This increase was primarily attributable to expenses incurred as a result of our expanded selling efforts and our support of our increasing customer base and headcount during 2002. The increase was also partially attributable to the $3.2 million increase in the expense related to our allowance for doubtful accounts.
Amortization of Deferred Compensation. The amortization of deferred compensation was approximately $3.3 million for both the year ending December 31, 2001 and the year ended December 31, 2002.
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Gain on Settlement of Vendor Litigation. In December 2002, we reached an agreement with a vendor to settle the litigation brought by that vendor. Under this settlement, we agreed to pay the vendor approximately $1.6 million in 2003. The settlement amount resulted in a gain of $5.7 million that was recorded in December 2002.
Depreciation and Amortization Expenses. Our depreciation and amortization expenses increased 151.1% from $13.5 million for the year ended December 31, 2001 to $34.0 million for the year ended December 31, 2002. This increase occurred primarily because we had more capital equipment and IRUs in service in 2002 than in the 2001. The increase was also attributable to an increase in amortization expense in the 2002 period over 2001. Amortization expense increased because we had more intangible assets during 2002 than in 2001.
Interest Income and Other. Our interest income decreased by 18.2% from $2.1 million for the year ended December 31, 2001 to $1.7 million for the year ended December 31, 2002, resulting from a decrease in marketable securities and a reduction in interest rates.
Interest Expense. Our interest expense increased by 356.7% from $7.9 million for the year ended December 31, 2001 to $36.3 million for the year ended December 31, 2002. The increase resulted primarily from an increase in borrowings under our previous Cisco Capital credit facility, an increase in the number of capital leases and the interest expense associated with our 71/2% Convertible Subordinated Notes Due 2007. The increase was partially offset by a reduction in interest rates.
Net Loss. As a result of the foregoing, our net loss of $66.9 million for the year ended December 31, 2001 increased to a net loss of $91.8 million for the year ended December 31, 2002.
Liquidity and Capital Resources
In assessing our liquidity, our management reviews and analyzes our current cash on-hand, our accounts receivable, foreign exchange rates, capital expenditure commitments, and our required debt payments and other obligations.
During 2003, we engaged in two transactions pursuant to which we significantly reduced our indebtedness and improved our liquidity. Prior to July 31, 2003 we were party to a $409 million credit facility with Cisco Systems Capital Corporation which we refer to as our previous Cisco credit facility. During the third quarter of 2003, we entered into agreements with Cisco Capital and certain of our existing investors pursuant to which, among other things: (1) Cisco Capital agreed to cancel the $269.1 million in principal amount of then-outstanding indebtedness and accrued interest and to return warrants exercisable for the purchase of 40,000 shares of our common stock in exchange for a cash payment of $20.0 million, the issuance of 11,000 shares of our Series F preferred stock, which are convertible into 3.4 million shares of our common stock and the issuance of an Amended and Restated Promissory Note for the aggregate principal amount of $17.0 million, and (2) we sold to certain of our then-existing investors preferred stock convertible into 12.7 million shares of our common stock, in exchange for $41.0 million in cash, a portion of which was used to make the $20.0 million cash payment to Cisco Capital.
In the first quarter of 2003, we entered an agreement with the holders of approximately $106.7 million in face value of 71/2% Convertible Subordinated Notes Due 2007 issued in September 2000 by our subsidiary Allied Riser, pursuant to which the noteholders agreed (1) to surrender their notes, including accrued and unpaid interest, in exchange for a cash payment of $5.0 million and the issuance of 3.4 million shares of our Series D preferred stock and 3.4 million shares of our Series E preferred stock, which shares were converted into a total of 34,263 shares of our common stock in the Cisco recapitalization, and (2) to dismiss with prejudice their litigation against Allied Riser, in exchange for a cash payment of $4.9 million.
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Cash Flows
The following table sets forth our consolidated cash flows for the years ended December 31, 2001, 2002, and 2003 and the six months ended June 30, 2003 and 2004.
|
Year Ended December 31, |
Six Months Ended June 30, |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2001 |
2002 |
2003 |
2003 |
2004 |
|||||||||||
|
|
|
|
(unaudited) |
||||||||||||
|
(in thousands) |
|||||||||||||||
Net cash used in operating activities | $ | (46,786 | ) | $ | (41,567 | ) | $ | (27,357 | ) | $ | (18,763 | ) | $ | (17,629 | ) | |
Net cash (used in) provided by investing activities | (131,652 | ) | (19,786 | ) | (25,316 | ) | (16,258 | ) | 26,480 | |||||||
Net cash provided by (used in) financing activities | 161,862 | 51,694 | 20,562 | 1,398 | (3,308 | ) | ||||||||||
Effect of exchange rates on cash | | (44 | ) | 672 | 564 | (418 | ) | |||||||||
Net (decrease) increase in cash and cash equivalents during period | $ | (16,576 | ) | $ | (9,703 | ) | $ | (31,439 | ) | $ | (33,059 | ) | $ | 5,125 | ||
Net Cash Used in Operating Activities. Net cash used in operating activities was $18.7 million for the six months ended June 30, 2003 compared to $17.6 million for the same period during 2004. 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 cash are payments made to our vendors and employees. Our net loss was $20.9 million for the six months ended June 30, 2003 compared to a net loss of $46.4 million for the six months ended June 30, 2004. Net loss for the six months ended June 30, 2003 was partially offset by a gain of $24.8 million related our settlement with certain Allied Riser noteholders. Depreciation and amortization, including the amortization of deferred compensation and the debt discount on the Allied Riser notes was $27.2 million for the six months ended June 30, 2003, and $34.8 million for the six months ended June 30, 2004. Changes in assets and liabilities resulted in a decrease to operating cash of $0.3 million for the six months ended June 30, 2003 and a decrease in operating cash of $5.3 million for the six months ended June 30, 2004. This occurred primarily because payments for accounts payable and accrued liabilities exceeded collections of accounts receivable during the six months ended June 30, 2003 and June 30, 2004 by $1.4 million and $7.8 million, respectively.
Net cash used in operating activities was $41.6 million for the year ended December 31, 2002 compared to $27.4 million for the year ended December 31, 2003. Net loss was $91.8 million for the year ended December 31, 2002. Net income was $140.7 million for the year ended December 31, 2003. Our net loss for the year ended December 31, 2002 includes an extraordinary gain of $8.4 million related to the Allied Riser merger. Net income for the year ended December 31, 2003 includes a gain of $215.4 million related to the restructuring of our credit facility with Cisco Capital and a $24.8 million gain related to the exchange of Allied Riser subordinated convertible notes. Depreciation and amortization including amortization of debt discount and deferred compensation was $45.9 million for the year ended December 31, 2002 and $70.2 million for the year ended December 31, 2003. Net changes in current assets and liabilities added back to the net loss to arrive at cash used in operating activities resulted in an increase to operating cash of $18.5 million for the year ended December 31, 2002 and $1.9 million for the year ended December 31, 2003. A $15.8 million and $12.0 million increase in accrued interest was included in the change in assets and liabilities for the years ended December 31, 2002 and 2003, respectively. Payments for accounts payable and accrued liabilities exceeded collections of accounts receivable by $12.8 million for the year ended December 31, 2002. Payments for accounts payable and accrued liabilities approximated collections of accounts receivable for the year ended December 31, 2003.
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Net cash used in operating activities was $46.8 million for the year ended December 31, 2001 compared to $41.6 million for the year ended December 31, 2002. The net loss was $66.9 million for the year ended December 31, 2001 and increased to $91.8 million for the year ended December 31, 2002. Included in these net losses were depreciation and amortization of $16.9 million for the year ended December 31, 2001, and $45.9 million for the year ended December 31, 2002. Net changes in assets and liabilities added back to the net loss to arrive at cash used in operating activities were $3.3 million for the year ended December 31, 2001 and $18.5 million for the year ended December 31, 2002. Payments for accounts payable and accrued liabilities approximated collections of accounts receivable for each period. A $15.8 million increase in accrued interest was included in the change in assets and liabilities for the year ended December 31, 2002. Net cash used in operating activities includes an extraordinary gain of $8.4 million and a gain on the settlement of vendor litigation of $5.7 million for the year ended December 31, 2002.
Net Cash (Used in) Provided By Investing Activities. Net cash used in investing activities was $16.3 million for the six months ended June 30, 2003 compared to net cash provided by investing activities of $26.5 million for the same period during 2004. Our primary sources of cash provided by investing activities during the first six months of 2004 was cash acquired of $4.7 million and $19.4 million from our acquisition of Firstmark in January 2004 and our merger with Symposium Omega in March 2004, respectively. Our purchases of property and equipment were $18.3 million for the six months ended June 30, 2003 and $4.0 million for the six months ended June 30, 2004. Our sales of short-term investments were $2.7 million for the six months ended June 30, 2003 and $2.3 million for the six months ended June 30, 2004. Net cash provided by investing activities for the six months ended June 30, 2004 also included proceeds from the sale of warrants acquired in the Firstmark transaction for $3.4 million.
Net cash used in investing activities was $131.7 million for the year ended December 31, 2001, $19.8 million for the year ended December 31, 2002 and $25.3 million for the year ended December 31, 2003. Our primary uses of cash during 2001 were $118.0 million for the purchase of property and equipment in connection with the deployment of our network, $11.9 million for the purchase of intangible assets in connection with the NetRail acquisition and $1.8 million for purchases of short term investments. Our primary uses of cash during 2002 were $75.2 million for the purchase of property and equipment in connection with the deployment of our network, $9.6 million for the purchase of intangible assets in connection with our PSINet acquisition, $3.6 million in connection with our acquisition of the minority interest in Shared Technologies of Canada, Inc. and $1.8 million for purchases of short term investments. Cash expenditures were partially offset during 2002 by the $70.4 million of cash and cash equivalents that we acquired in connection with the Allied Riser merger. Our primary use of cash during 2003 was $24.0 million for the purchase of property and equipment in connection with the deployment of our network.
Net Cash Provided by (Used in) Financing Activities. Financing activities provided net cash of $1.4 million for the six months ended June 30, 2003 and used net cash of $3.3 million for the six months ended June 30, 2004. Net cash provided by financing activities during the first six months of 2003 resulted principally from proceeds from borrowings under the previous Cisco credit facility of $8.0 million offset by a $5.0 million payment related to the Allied Riser note exchange and payments under our capital leases of $1.6 million. Net cash used in financing activities during the first six months of 2004 was principally related to a $1.2 million payment to LNG Holdings and $2.1 million in payments under our capital leases.
Financing activities provided net cash of $161.9 million for the year ended December 31, 2001, $51.7 million for the year ended December 31, 2002 and $20.6 million for the year ended December 31, 2003. Net cash provided by financing activities during 2001 resulted principally from borrowings under our previous Cisco credit facility of $107.6 million and net proceeds of $61.3 million from the sale of our Series C preferred stock, partially offset by $12.8 million in capital lease
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repayments. Net cash provided by financing activities during 2002 resulted principally from borrowings under our previous Cisco credit facility of $54.4 million, partially offset by $2.7 million in capital lease repayments. Net cash provided by financing activities during 2003 resulted principally from borrowings under our previous Cisco credit facility of $8.0 million and net proceeds of $40.6 million from the sale of our Series G 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.
Cash Position and Indebtedness
Our total indebtedness, net of discount, at December 31, 2001, 2002 and 2003 was $202.5 million, $347.9 million and $83.7 million, respectively. During the year ended December 31, 2003, the Allied Riser note exchange and related agreement and the Cisco recapitalization in particular had a significant impact on our liquidity and our level of indebtedness. At June 30, 2004, our total cash and cash equivalents were $13.0 million and our total indebtedness was $130.9 million. Total indebtedness includes $108.5 million of capital lease obligations for dark fiber, which is primarily held pursuant to 15-25 year indefeasable rights of use, or IRU's. Of this $108.5 million, approximately $6.0 million is considered a current liability.
Amended and Restated Cisco Note and Second Amended and Restated Cisco Note
In connection with the Cisco recapitalization, we amended our credit agreement with Cisco Capital. The Amended and Restated Credit Agreement became effective at the closing of the recapitalization on July 31, 2003.
Our remaining $17.0 million of indebtedness to Cisco is evidenced by a promissory note, which we refer to as the Amended and Restated Cisco Note. The Amended and Restated Cisco Note eliminated the covenants related to our financial performance. Cisco Capital retained its senior security interest in substantially all of our assets, except that we are permitted to subordinate Cisco Capital's security interest in our accounts receivable. We plan to enter into an amendment of this note immediately prior to this offering. Pursuant to this amended note, which we refer to as the Second Amended and Restated Cisco Note, we will repay $7.0 million of the $17.0 million of aggregate indebtedness with a part of the proceeds of this offering. No interest will accrue or become payable on the Second Amended and Restated Cisco Note for the first 30 months unless we default under the terms of the Second Amended and Restated Cisco Note. The remaining $10.0 million principal and interest is paid as follows: a $4.0 million principal payment is due on February 1, 2006, a $3.0 million principal payment plus interest accrued is due on February 1, 2007, and a final principal payment of $3.0 million plus interest is due on February 1, 2008. When the indebtedness under the Second Amended and Restated Cisco Note begins to accrue interest in 2006, interest accrues at the 90-day LIBOR rate plus 4.5%.
The Second Amended and Restated Cisco Note is also subject to mandatory prepayment in full upon the occurrence of the closing of any change in control of us, our completion of any equity financing or receipt of loan proceeds above $30.0 million following this offering, 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, as each of these events is defined in the agreement.
The Cisco recapitalization was considered a troubled debt restructuring under 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 estimated future interest payments.
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Contractual Obligations and Commitments
The following table summarizes our contractual cash obligations and other commercial commitments as of June 30, 2004:
|
Payments due by period |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Total |
Less than 1 year |
1-3 years |
4-5 years |
After 5 years |
||||||||||
|
(in thousands) |
||||||||||||||
Long term debt | $ | 28,033 | $ | | $ | 22,869 | $ | 5,164 | $ | | |||||
Capital lease obligations | 177,257 | 16,204 | 28,189 | 24,281 | 108,583 | ||||||||||
Operating leases (1) | 171,290 | 25,206 | 39,496 | 27,207 | 79,381 | ||||||||||
Unconditional purchase obligations | 3,694 | 246 | 492 | 492 | 2,464 | ||||||||||
Total contractual cash obligations | $ | 380,274 | $ | 41,656 | $ | 91,046 | $ | 57,144 | $ | 190,428 | |||||
Capital Lease Obligations. The capital lease obligations above were incurred in connection with our IRUs for intercity and intracity 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 $108.5 million at June 30, 2004. These leases generally have terms of 15 to 25 years.
Future Capital Requirements
Our future capital requirements will depend on a number of factors, including our success in increasing the number of customers using our services, regulatory changes, competition, technological developments, potential merger and acquisition activity and the economy. We believe that if we are able to increase the number of customers using our services as planned, our current cash position is sufficient to fund our operations until we generate more cash than we consume. If we are unable to achieve revenue growth or if we have significant unplanned costs or cash requirements, we may need to raise additional funds through the issuance of debt or equity. We cannot assure you that such financing will be available on terms acceptable 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 or require us to restructure our business. If additional funds are raised by issuing equity securities, 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 results of operations.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial 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.
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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 principals generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates including those related to allowances for doubtful accounts, revenue allowances, long-lived assets, contingencies and litigation, and the carrying values of assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the 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 accounting policies we believe to be most critical to understanding our financial results and condition and that require complex, significant and subjective management judgments are discussed below. We have not experienced significant revisions to our assumptions except to the extent that they result from (1) variations in the trading price of our common stock which has caused us to revise the assumptions that we use in determining deferred compensation, (2) changes in the amount and aging of our accounts receivable which have caused us to revise the assumptions that we use in determining our allowance for doubtful accounts and (3) changes in interest rates which have caused us to revise the assumptions that we use in determining the present value of future minimum lease payments.
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 offered to certain customers are recorded as a reduction of revenue when granted or ratably over the estimated customer life. Fees billed in connection with customer installations and other upfront charges are deferred and recognized ratably over the estimated customer life. We determine the estimated customer life using a historical analysis of customer retention. If our estimated customer life increases, we will recognize installation revenue over a longer period. We expense direct costs associated with sales and new customer setup as incurred.
Allowances for Sales Credits and Unfulfilled Purchase Obligations
We have established allowances to account for sales credit adjustments and unfulfilled contractual purchase obligations.
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obligations invoiced to our customers and with respect to which we are continuing to seek payment. Once we submit these accounts receivable to a third party collection agency, this allowance is reduced.
Valuation Allowances for Doubtful Accounts Receivable and Deferred Tax Assets
We have established allowances that we use in connection with valuing expense charges associated with uncollectible accounts receivable and our deferred tax assets.
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 the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards (SFAS) No. 144, 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 our best estimate of future undiscounted cash flows expected to result from the use of the assets and their eventual disposition over the remaining useful life of the primary asset in the asset group. As of December 31, 2002 and December 31, 2003, we tested our long-lived assets for impairment. 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 our best 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, we believe that currently the fair value of our long-lived assets including our network assets and IRUs are significantly below the amounts we originally paid for them and may be less than their current depreciated cost basis. Our best estimate of future undiscounted cash flows is sensitive to changes in our estimated cash flows and any change in the lease period or in the designation of our primary asset in the asset group.
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Business Combinations
We account for our business combinations pursuant to 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. We determine estimated fair values using quoted market prices, when available, or the using present values determined at appropriate current interest rates. Consideration not in the form of cash is measured based upon the fair value of the consideration given.
Goodwill and Other Intangibles
We account for our intangible assets pursuant to SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142 we determine the useful lives of our intangible assets based upon the expected use of the intangible asset, contractual provisions, obsolescence and other factors. We amortized our intangible assets on a straight-line basis. We presently have no intangible assets that are not subject to amortization.
Other 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 as construction-in-progress. Construction-in-progress includes costs incurred under the construction contract, interest, 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 the fair market value of our Series H preferred stock based upon the number of common shares the Series H preferred stock converts into and the trading price of our common stock on the grant date. The fair market value of our Series H preferred stock is sensitive to changes in the trading price of our common stock.
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 December 31, 2003 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.
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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 operations or financial position.
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.
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.
Recent Accounting Pronouncements
In March 2004, the FASB ratified the consensuses reached by Emerging Issues Task Force in Issue No. 03-06, Participating Securities and the Two-Class Method under FASB Statement No. 128 ("EITF 03-06"). EITF 03-06 clarifies the definitional issues surrounding participating securities and requires companies to restate prior earnings per share amounts for comparative purposes upon adoption. We adopted the provisions of EITF 03-06 in the second quarter of 2004, and restated our previously disclosed basic earnings per share amounts to include our participating securities in basic earnings per share when including such shares would have a dilutive effect. As a result of the adoption and for comparative purposes, basic income per share available to common shareholders decreased from $11.00 to $2.78 for the quarter ended March 31, 2003, from $271.80 to $12.64 for the quarter ended September 30, 2003, and from $229.18 to $11.18 for the year ended December 31, 2003.
Quantitative And Qualitative Disclosures About Market Risk
All of our financial interests that are sensitive to market risk are entered into for purposes other than trading. Our primary market risk exposure is related to our marketable securities. We place our marketable securities investments in instruments that meet high credit quality standards as specified in our investment policy guidelines. Marketable securities were approximately $14.8 million at June 30, 2004, $13.0 million of which are considered cash equivalents and mature in 90 days or less and $1.8 million are short term investments consisting of commercial paper of which $0.7 million is restricted for collateral against letters of credit. We also own commercial paper investments and
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certificates of deposit totaling $1.3 million that are classified as other long-term assets. These investments are also restricted for collateral against letters of credit.
If market rates were to increase immediately and uniformly by 10% from the level at June 30, 2004, the change to our interest sensitive assets and liabilities would not have a material effect on our financial position, results of operations and cash flows over the next fiscal year. A 10% increase in the weighted-average interest rate for the six months ended June 30, 2004 would have increased our interest expense for the period by approximately $0.6 million.
Interest on the Second Amended and Restated Cisco Note will not accrue until February 2006, unless we default under the terms of the note. When the note accrues interest, interest accrues at the 90-day LIBOR rate plus 4.5%.
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Overview
We are a leading facilities-based provider of low-cost, high-speed Internet access and Internet Protocol connectivity. Our network has been designed and optimized to transmit data using Internet Protocol, which provides us with significant cost and performance advantages over legacy networks. We deliver our services to more than 5,000 small and medium-sized businesses, communications service providers, and other bandwidth-intensive organizations in North America and Europe. Our primary service is providing Internet access at a speed of 100 Megabits per second, much faster than typical Internet access currently offered to businesses, and is delivered through our own facilities running 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 intercity transport facilities. The network is physically connected entirely through our facilities to over 950 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 colocation facilities, data centers and single-tenant office buildings. Because of our network architecture, we are not dependent on local telephone companies to serve our on-net customers. In addition to providing our on-net services, we also provide Internet connectivity to customers that are not located in buildings directly connected to our network. 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 emphasize the sale of on-net services because sales of these services generate higher gross profit margins. For the six months ended June 30, 2004, 65.6% of our net service revenue was generated from on-net customers as compared to 53.1% in the same period in 2003.
Our network allows us to respond to the growing demand for low-cost, high-speed Internet connectivity. On average, we currently serve approximately 4% of the tenants in each of our multi-tenant on-net buildings. We believe our multi-tenant on-net buildings have an average of 45 tenants. In addition, we currently serve less than 1% of the approximate 172,000 small and medium-sized businesses in the geographic regions in which we offer our off-net services. We also operate 29 data centers comprising over 300,000 square feet throughout North America and Europe that allow customers to colocate their equipment and access our network. We intend to continue to expand our addressable market by selectively adding buildings to our network.
Competitive Advantages
We believe we address many of the Internet Protocol, or IP, data communications needs of small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations by offering them high-quality Internet service at attractive prices.
Low Cost of Operation. We have built our network on a facilities-based platform to optimally deliver IP services. We believe our network architecture gives us a cost advantage over our competitors, who have constructed their networks to overlay legacy voice networks. We have minimized the cost of constructing and maintaining our network by acquiring strands of fiber from carriers with large unused capacity. We also have minimized our capital expenditures by acquiring financially distressed companies or their assets at a significant discount to their original cost. Our high-capacity network's existing connections to over 950 buildings enable us to increase the total number of customers we serve. We believe our high operating leverage, combined with the relatively low capital expenditures we expect to incur over the foreseeable future, provides the foundation for generating free cash flow. Finally, our focus on a simple set of Internet connectivity services reduces our costs of provisioning and customer support.
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Independent Network. Our high-speed on-net Internet access service does not rely on infrastructure controlled by 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 service, 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 nine days. Our off-net services are generally installed within 30 days and utilize more traditional circuits, such as T1 and T3 lines, purchased from local telecommunications providers.
Reliable Service. Over the last 33 months, our network has averaged 99.99% customer connection availability. The majority of our network is configured in a ring structure that enables us to route customer traffic in either direction around the network rings both at the metropolitan and intercity levels. The availability of two data transmission paths around each ring serves as a backup that minimizes loss of service in the event of network failure or damage.
High Quality. We are able to offer high-quality Internet service due to our network, which was designed solely to transmit IP data, and dedicated intracity bandwidth for each customer. Our intracity network is designed to allow customers to transmit and receive data simultaneously at the maximum stated rate for their connection without performance degradation. This design increases the speed and throughput of our network and reduces the number of data packets dropped during transmission.
Experienced Management Team. Our management team is composed of seasoned executives with extensive expertise in the communications industry as well as knowledge of the markets in which we operate. Our management team has designed and built our network and has guided us through the recent telecommunications industry downturn. The team has also integrated our network assets, customers and service offerings we acquired through eight major and three minor acquisitions.
Our Strategy
We intend to become the leading provider of high-capacity IP data services to customers in the markets we serve and to increase 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 leverage our high-capacity network to respond to the growing demand among businesses for high-speed Internet service. We currently offer services with speeds ranging between 500 Kilobits per second, or Kbps, and 1,000 Megabits per second, or Mbps. Our primary service is offered at a speed of 100 Mbps, much faster than typical Internet access currently offered to businesses.
Pursuing On-Net Customer Growth. We intend to expand and intensify the efforts of our direct field sales organization. Our direct field sales organization markets to tenants in our on-net buildings. Our marginal cost to serve new on-net customers is low because of our network design and focused service offerings. We estimate that we now serve only 4% of the tenants in our on-net buildings, providing us with a significant opportunity for customer and revenue 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, particularly in Europe.
Selectively Expanding Our Service Offerings. We have recently expanded the geographic reach of our core Internet protocol-based services to include Europe. We will continue to evaluate opportunities to offer complementary application services on our network, such as voice-over-Internet Protocol, or VoIP, remote storage, Internet Protocol virtual private networks, or IP VPNs, and secure networks. In certain instances, the development and deployment of new technologies may be dependent on the successful implementation of network upgrades. The success of new service offerings also may be dependent on customer acceptance.
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Selectively Pursuing Acquisition Opportunities. Since our inception, we have made a number of acquisitions that have enhanced our business. In the first quarter of 2004, we consummated the acquisition of the European portion of our network. We will continue to evaluate opportunities to acquire network assets and customers through selective acquisitions. We may also use acquisitions to expand into new geographic markets.
Our Network
Our network is comprised of in-building riser facilities, metropolitan optical networks, metropolitan traffic aggregation points and intercity transport facilities. We deliver a high level of technical performance because our network is optimized for Internet protocol traffic. It is more reliable and less costly for Internet Protocol traffic than networks built as overlays to traditional telephone networks.
Our network encompasses:
Intercity Networks
The North American portion of our inter-city network consists of two strands of optical fiber that we have acquired from WilTel Communications and 360networks under pre-paid IRUs. 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 through 2020 and may extend the term for two five-year periods without additional payment. To serve the Toronto market, we lease two strands of optical fiber under pre-paid IRUs from affiliates of 360networks. This fiber runs from Buffalo to Toronto. The 360networks IRUs expire in 2020, after which title to the fiber is to be transferred to us. 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. That equipment is located approximately every 40 miles along the network and in our metropolitan aggregation points and the on-net buildings we serve.
In Spain and Portugal, we have approximately 1,300 route miles of fiber secured from La Red Nacional de los Ferrocarriles Espanoles. We have the right to use this fiber pursuant to an IRU that expires in 2012. In France, the United Kingdom, Belgium, the Netherlands and Switzerland, we have approximately 5,100 route miles of fiber secured from Neuf Telecom and Telia. We have the right to use the Neuf Telecom fiber pursuant to an IRU that expires in 2020. In Germany and Austria, we have approximately 2,000 route miles of fiber secured from MTI and Telia. We have the right to use the MTI fiber pursuant to an IRU that expires in 2019. We have the right to use all of our Telia fiber pursuant to an IRU expiring in 2011 with an option to extend to 2019.
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Intracity Networks
In each North American metropolitan area in which we provide high-speed on-net Internet access service, the backbone network is connected to a router connected to one or more metropolitan optical networks. These metropolitan networks also consist of optical fiber that runs from the central router in a market into routers located in on-net buildings. The metropolitan fiber runs in a ring architecture, which provides redundancy so that if the fiber is cut data can still be transmitted to the central router by directing traffic in the opposite direction around the ring. The router in the building provides a connection to each on-net customer.
The European intracity networks for Internet access service use essentially the same architecture as in North America, with fiber rings connecting routers in each on-net building we serve to a central router. While these intracity networks were originally built as legacy networks providing point-to-point services, we are using excess capacity on these networks to implement our IP network.
Within the North American cities where we offer off-net Internet access service, we lease circuits, typically T1 lines, from telecommunications carriers, primarily local telephone companies, to provide the last mile connection to the 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. In Europe, we have begun to deploy off-net aggregation equipment across our network.
In-Building Networks
We connect our routers to a cable containing 12 to 288 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 over 390 other 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 customer's of other ISPs. We are considered a Tier 1 ISP and, as a result, have settlement-free peering arrangements with 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. Less than 3% of our traffic is handled this way.
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Network Management and Control
Our primary network operations centers are located in Washington, D.C. and Madrid. 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 intracity and long-haul networks, we have deployed field engineers across North America and Europe. In addition, we have maintenance contracts with third party vendors that specialize in optical and routed networks.
Our Services
We offer high-speed Internet access and IP 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 | |
Colocation with Internet Access | 2 to 1,000 | |
Point-to-Point | 1.5 to 10,000 | |
Off-Net Services |
||
T1 |
1.5 |
|
T3 | 45 |
We offer on-net services in 25 metropolitan markets and over 950 buildings of which more than 850 are located in North American and more than 75 in Europe. Our most popular on-net service in North America is our Fast Ethernet service. The European portion of our network was historically used to offer point-to-point services. We acquired and re-architected this network to begin offering our IP-based services in Europe. We also offer colocation services in 29 locations in North America and Europe. This on-net service offers Internet access combined with equipment rack space in a Cogent facility, allowing the customer to locate a server or other equipment at that location and connect to our Internet service. We emphasize the sale of on-net services because sales of 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 34 metropolitan markets in North America. These services are generally provided to small and medium-sized businesses located within a ten-mile radius of these facilities.
We support a number of non-core services assumed with certain of our acquisitions. These services include email service, dial-up Internet, shared web hosting, managed web hosting, managed security, point-to-point services, and voice services in Toronto, Canada only. For the six months ended June 30, 2004, these services accounted for approximately 12.1% of our revenue; however, we do not actively market such non-core services because these services do not take advantage of our network assets. We expect the revenue from these non-core services to decline. We expect the growth of our on-net and off-net Internet services to compensate for this loss.
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Sales and Marketing
We employ a relationship-based sales and marketing approach. We believe this approach and our commitment to customer service increases the effectiveness of our sales efforts. We market our services through two primary sales channels as summarized below:
Direct Sales. As of September 15, 2004, our direct sales force included 62 full-time employees focused solely on acquiring and retaining on-net customers. Each member of our direct sales force is assigned a specific market or territory, based on customer type and geographic location. Of these direct sales force employees, 49 have individual quota responsibility. Direct sales personnel are compensated with a base salary plus quota-based commissions and incentives. Each end-user sales professional is assigned 15 to 20 buildings on which to call, providing them with a clearly defined and manageable base of property managers and potential customers. Each carrier sales professional is assigned all of the on-net carrier-neutral facilities in a major metropolitan area. We use a customer relationship management system to efficiently track activity levels and sales productivity in particular geographic areas. Furthermore, our 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.
Telesales. As of September 15, 2004, we employed 11 full-time outbound telemarketing sales personnel in Herndon, Virginia who are focused solely on selling our off-net services to our target business customers. Of these telesales employees, 9 have individual quota responsibility. Telesales personnel are compensated with a base salary plus quota-based commissions and incentives.
Marketing. As a result of our direct sales approach, we have generally not spent funds on television, radio or print advertising. Our marketing efforts are designed to drive awareness of our products and services, identify qualified leads through various direct marketing campaigns and provide our sales force with product brochures, collateral materials and relevant sales tools to improve the overall effectiveness of our sales organization. In addition, we conduct public relations efforts focused on cultivating industry analyst and media relationships with the goal of securing media coverage and public recognition of our Internet communications services. Our marketing organization also is responsible for our product strategy and direction based upon primary and secondary market research and the advancement of new technologies.
Competition
While we are a leading provider of high-speed IP connectivity, the market in which we operate is highly competitive. We face competition from incumbent carriers, Internet service providers and facilities-based network operators, many of whom are much bigger than us, have significantly greater financial resources, and better-established brand names and large, existing installed customer bases in the markets in which we compete. We also face competition from other 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 title holders. We are reliant 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 T-1 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. Because our fiber optic networks have been recently installed compared to those of the
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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 services supported by these legacy networks, such as circuit-switched voice and frame relay. While the Internet access speeds offered by traditional ISPs typically do not match our on-net offerings, these slower services usually are priced lower than our offerings and thus provide competitive pressure on pricing, particularly for more price-sensitive customers. Additionally, some of our competitors are in bankruptcy or may soon emerge from bankruptcy, and some already have done so. Because the bankruptcy process allows for the discharge of debts and rejection of certain obligations, these competitors may have more pricing flexibility and a lower cost structure than we do. 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.
Employees
As of September 15, 2004, we had 251 employees. Nineteen of our employees in France are represented by a works counsel and a union. We intend to enter into discussions with our employees and their representatives in France regarding possible revisions of their employment terms. We believe at this time that we have satisfactory relations with our employees.
Properties
We own no material real property in North America. We lease our headquarters facilities consisting of approximately 15,370 square feet in Washington, D.C. We also lease approximately 196,000 square feet of space in 40 locations to house our colocation facilities, regional offices and operations centers. The lease for our headquarters is with an entity controlled by our Chief Executive Officer and expires on August 31, 2005. The terms of our other leases generally are for ten years with two five-year renewal options. We believe that these facilities are generally in good condition and suitable for our operations. In addition to the above leases, we also have, from our acquisitions, leases for approximately 89,000 square feet of office space in 10 locations. All of this space is currently sublet.
Through the acquisition of our French and Spanish subsidiaries in January, 2004, we acquired three properties in France. All three properties are data centers and points-of-presence, 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 or approximately $6.0 million. One of the three properties, located in Lyon, France, is currently under contract to be sold for 3.9 million euros, or approximately $4.6 million, and is expected to close in mid-2005, subject to the purchaser obtaining the necessary entitlements to redevelop the property. Through our French and Spanish subsidiaries, we also lease approximately 205,000 square feet of space to house our colocation facilities, regional offices and operations centers. Approximately 160,000 square feet of the total are used for active POP locations, which house our network equipment and provide colocation space for our customers and have an average size of 8,800 square feet. The terms of these leases generally are for nine years with an opportunity to terminate the lease every three years. Much of the general office space and non-active POP locations are currently on the market to be sublet to third parties. We believe that these facilities are generally in good condition and suitable for our operations.
Legal Proceedings
In 2002, a vendor of telecommunications capacity invoiced us for approximately $1.7 million in excess of what we believe we owed the vendor. Our relationship with the vendor ended in early 2003. The vendor has initiated an arbitration proceeding related to this dispute. We do not know the amount the vendor will claim under the arbitration, but it may be substantially larger than the amount invoiced. The vendor appears to plan to enlarge its claim to include claims for services the vendor claims we were contractually obligated to purchase even after we ceased doing business with the vendor. We
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believe the vendor intends to claim current amounts due of $8 million and future payments due through 2019 of $51 million. We intend to vigorously defend our position related to this matter. While no assurances can be given, we do not expect that this dispute will have a material adverse effect on our business, financial condition or results of operations. We are also involved in other legal proceedings in the normal course of our business that we do not expect to have a material adverse affect on our business, financial condition or results of operations.
Regulation
In the United States, the Federal Communications Commission (FCC) regulates common carriers' interstate services and state public utilities commissions exercise jurisdiction over intrastate basic telecommunications services. Our Internet service offerings are not currently regulated by the FCC or any state public utility 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's commercial tenants.
Our subsidiary, Shared Technologies of Canada, offers voice 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 to the extent these regulations change and to the extent we begin using facilities in a manner that subjects us to these 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 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 European Union. We believe that each of our subsidiaries has the necessary licenses 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 requirements.
The laws related 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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Directors and Executive Officers
The following table sets forth information concerning our directors and executive officers as of September 15, 2004.
Name |
Age |
Position |
||
---|---|---|---|---|
Dave Schaeffer | 48 | Chairman of the Board of Directors and Chief Executive Officer | ||
Thaddeus Weed | 43 | Chief Financial Officer | ||
R. Reed Harrison III | 55 | President and Chief Operating Officer | ||
Robert Beury, Jr. | 51 | Chief Legal Officer | ||
R. Brad Kummer | 56 | Chief Technology Officer and Vice President Optical Transport | ||
Timothy O'Neill | 48 | Vice President of Engineering Construction | ||
Mark Schleifer | 35 | Vice President of IP Engineering | ||
Jeff Karnes | 33 | Vice President of Retail Sales | ||
Les Hankinson | 52 | Vice President Carrier and International Sales | ||
Warren Thrasher | 57 | Vice President of Global Customer Network Operations and Chief Information Officer | ||
Edward Glassmeyer | 62 | Director | ||
Steven Brooks | 52 | Director | ||
Jean-Jacques Bertrand | 51 | Director | ||
Erel Margalit | 41 | Director | ||
Michael Carus | 38 | Director | ||
Timothy Weingarten | 28 | Director |
Dave Schaeffer founded our company in August 1999 and is the Chairman of the board of directors, President and Chief Executive Officer. Prior to founding the company, Mr. Schaeffer was the founder of Pathnet, Inc., a broadband telecommunications provider, where he served as Chief Executive Officer from 1995 until 1997 and as Chairman from 1997 until 1999. Mr. Schaeffer has been a director since 1999.
Thaddeus Weed joined us in February 2000 and served as Vice President and Controller until May 2004 when he became our Chief Financial Officer. From 1997 to 1999, Mr. Weed served as Senior Vice President of Finance and Treasurer at Transaction Network Services where Mr. Weed undertook a broad range of financial management responsibilities. These responsibilities included financial planning, forecasting, budgeting, financial modeling, acquisition, and international expansion strategies and pro-forma analyses. From 1987 to 1997, Mr. Weed was employed at Arthur Andersen LLP where he served as Senior Audit Manager.
R. Reed Harrison III joined us in July of 2004 as President and Chief Operating Officer. Prior to joining us, Mr. Harrison served as Senior Vice President Worldwide Network Engineering and Operations for AT&T, where he held a variety of senior management positions beginning in 1996. During the twelve years prior to that time, Mr. Harrison served in senior management positions, including President of the GTE Global Business Unit for AT&T Network Systems and Bell Laboratories.
Robert Beury, Jr. joined us in September 2000 as Vice President and General Counsel. His title was changed to Chief Legal Officer in May 2004. Prior to joining us, Mr. Beury served as Deputy General Counsel of Iridium LLC, a mobile satellite service provider, from 1994 to 2000. From 1987 to 1994 Mr. Beury was General Counsel of Virginia's Center for Innovative Technology, a non-profit corporation set up to develop the high tech industry in Virginia.
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R. Brad Kummer joined us in February 2000 as Vice President and Chief Technology Officer. Mr. Kummer spent the 25 years prior to joining us at Lucent Technologies (formerly Bell Laboratories), where he served in a variety of research and development and business development roles relating to optical fibers and systems. In his most recent work at Lucent, he was responsible for optical fiber systems engineering for long haul and metropolitan dense wavelength division multiplexing systems.
Timothy O'Neill joined us in January 2001 as the Vice President of Engineering Construction. He is responsible for network construction and provisioning. From 1999 to 2001, Mr. O'Neill was employed at @Link Networks, Inc. where he served as Chief Network Officer. While at @Link Networks, Inc., Mr. O'Neill was responsible for engineering, implementing and operating an integrated communications network.
Mark Schleifer joined us in October 2000 and serves as Vice President, IP Engineering. From 1994 to 2000, Mr. Schleifer served as Senior Director, Network Engineering at DIGEX/Intermedia, Incorporated, a provider of high-end managed Web and application hosting services. At DIGEX/Intermedia, Mr. Schleifer managed the Network Engineering group, Capacity Planning group, and Research and Development group. He was responsible for all technical aspects of initiating customer service, network troubleshooting, field installations, and new equipment testing for the leased line business. Mr. Schleifer also coordinated peering and backbone circuit deployment to maintain network throughput and availability.
Jeff Karnes joined us in May of 2004 as Vice President of Retail Sales. Prior to joining us, Mr. Karnes served Vice President of Regional Sales at UUNet division of MCI Communications, where he had served in a number of positions in the sales organization since joining UUNet in 1995.
Les Hankinson joined us in April 2004 as Vice President Carrier and International Sales. Mr. Hankinson has held numerous executive positions during his thirty year career in telecommunications. His recent background includes serving both large Tier 1 and emerging carriers. He has wholesale experience both domestically and internationally. He was the Senior Vice President of Global Sales at Universal Access from November 2002 to February 2004, Interoute from November 2001 to 2002, and FiberNet from October 1999 to October 2001, and the Vice President/General Manager for British Telecom's worldwide wholesale voice business from December 1990 to October 1999.
Warren Thrasher joined Cogent Communications as Vice President of Global Customer Network Operations and Chief Information Officer in August 2004. Prior to joining Cogent, he was Director of Network Engineering and Operations at AT&T, leading the expansion of its Mid-Atlantic network build-out. Mr. Thrasher has over 30 years experience in telecom at AT&T, Qwest, Bell South, and Bellcore (now part of Science Applications International Corporation). As Vice President at AT&T and a General Manager at BellSouth, he planned and executed the restructuring of large multi-functional organizations to reduce costs, improve quality, and shorten cycle times.
Edward Glassmeyer has served on our board of directors since 2000. Mr. Glassmeyer was with Citicorp Venture Capital from 1968 to 1970 and The Sprout Capital Group, where he was Managing Partner from 1971 to 1974. He co-founded Charter Oak Enterprises, a merchant bank, in 1974. Mr. Glassmeyer serves on the board of directors of a number of portfolio companies of Oak Investment Partners, a venture capital firm that he co-founded in 1978. He was a founding director of the National Venture Capital Association in 1973, and has served as an Overseer of The Amos Tuck School of Business at Dartmouth College since July 1996.
Steven Brooks became a director in October 2003. Mr. Brooks currently serves as Managing Partner of Broadview Capital Partners, which he co-founded in 1999. From 1997 until 1999, Mr. Brooks headed the technology industry mergers and acquisition practice at Donaldson, Lufkin & Jenrette.
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Previously, Mr. Brooks held a variety of positions in the investment banking and private equity fields, including: Head of Global Technology Banking at Union Bank of Switzerland, Managing Partner of Corporate Finance at Robertson Stephens, founder and Managing Partner of West Coast technology investment banking at Alex Brown & Sons, and Principal at Rainwater, Inc., a private equity firm in Fort Worth, Texas. Mr. Brooks is a member of the Board of Directors of VERITAS Software Corporation, Pharsight Corporation and Proxim Corporation, as well as a number of private companies.
Jean-Jacques Bertrand became a director in April 2004. Mr. Bertrand has been Managing Partner of BNP Private Equity SA since 1998 and led the telecommunications and media group of BNP SA from 1990 to 1998. Prior to that, Mr. Bertrand held senior management functions with France Telecom and was appointed special adviser to the French Minister of Communications. He sits on the board of directors of Genesys SA, Grupo Multitel SA and Musiwave SA.
Erel Margalit has served on our board of directors since 2000. Mr. Margalit has been Managing General Partner of Jerusalem Venture Partners since August 1997. He was a general partner of Jerusalem Pacific Ventures from December 1993 to August 1997. From 1990 to 1993, Mr. Margalit was Director of Business Development of the City of Jerusalem. Mr. Margalit is a director of CyOptics, Inc., Sepaton, Inc., MagniFire Websystems, Inc., Native Networks, Ltd. and Cyber-Ark Software, Inc. Mr. Margalit, in his capacity as director of a company in Israel, is the subject of a proceeding in which the tax authorities have alleged that the company (which is unrelated to us) failed to pay certain taxes. The proceeding is classified as criminal under the laws of Israel.
Michael Carus became a director in October 2003. Mr. Carus has been a general partner and Chief Financial Officer of Jerusalem Venture Partners since July 2001. Prior to joining Jerusalem Venture Partners, Mr. Carus served as the Executive Vice President, Chief Operating Officer and Chief Financial Officer at Fundtech, Inc. from May 1997 to July 2001. Prior to that, Mr. Carus held various senior management positions at Geotek Communications, Inc., from May 1995 to May 1997, and he was a CPA and Manager of Business Assurance at Coopers and Lybrand from August 1988 to May 1995. Mr. Carus is a director of Bristol Technology, Inc., Oblicore LTD, Techknowledge LTD and Bridgewave Communications, Inc.
Timothy Weingarten became a director in October 2003. Mr. Weingarten is a principal at Worldview Technology Partners, and from 1996 to 2000 was a member of the telecom equipment research group at Robertson Stephens and Company. Mr. Weingarten is also a member of the board of directors of Force10 Networks, KineticTide, Movaz Networks, and Ooma Inc.
Each of our directors has been elected as a member of the board of directors pursuant to an agreement among our company and certain of our preferred stock investors, whereby we have agreed to nominate certain designees to the board of directors and such preferred stock investors have agreed to vote for such designees.
Board of Directors and Officers
Our board of directors currently consists of seven directors. Messrs. Glassmeyer, Margalit, Weingarten, Brooks, Carus and Bertrand are independent as the term is defined in Section 121(A) of the listing standards of the American Stock Exchange.
Our directors may be removed either with or without cause at any meeting of our stockholders by a majority vote of those stockholders represented and entitled to vote at such meeting. However, pursuant to our Third Amended and Restated Stockholders' Agreement, certain of our preferred stockholders that currently have the voting power to determine the outcome of such a vote have agreed not to vote to remove any member of the board of directors unless the party that designated that member for nomination to the board of directors also votes to remove that member, and in the case that such nominating party votes to remove its designee, such other preferred stockholders and our
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other affiliates have agreed to vote to remove the designee. We anticipate that the Stockholders Agreement will be terminated at the completion of this offering.
Committees of our Board of Directors
Our board of directors directs the management of our business and affairs, as provided by Delaware law, and conducts its business through meetings of the board of directors and its audit and compensation committees. In addition, from time to time, special committees may be established under the direction of the board of directors when necessary to address specific issues.
Audit Committee. Our board of directors has established an audit committee. The audit committee consists of Messrs. Carus, Glassmeyer and Margalit, each of whom is "independent", as the term is defined in Section 121(A) of the listing standards of the American Stock Exchange and Rule 10A-3 of the Securities Exchange Act of 1934, as amended. Each member of the audit committee is able to read and understand fundamental financial statements, including a company's balance sheet, income statement, and cash flow statement. Our board of directors has determined that Mr. Carus is "financially sophisticated" as that term is defined in Section 121(A) of the listing standards of the American Stock Exchange and Rule 10A-3 of the Securities Exchange Act of 1934, as amended and is an "audit committee financial expert" as defined by the rules and regulations of the SEC. Our board of directors has adopted an audit committee charter meeting the applicable standards of the American Stock Exchange.
The audit committee meets periodically with management and our independent accountants to review their work and confirm that they are properly discharging their respective responsibilities. The audit committee also:
Compensation Committee. The compensation committee, established by our board of directors, currently consists of Messrs. Margalit, Glassmeyer and Brooks, each of whom is independent as the term is defined in Section 121(A) of the listing standards of the American Stock Exchange. The compensation committee administers our stock-based compensation plans, reviews management recommendations with respect to option grants, and takes other actions as may be required in connection with our compensation and incentive plans.
Director Nominations. We did not have a standing nominating committee or a committee performing a similar function in 2003. Historically, the board of directors has not considered a nominating committee necessary in that there have been few vacancies on our board, and vacancies have been filled either through discussions between our Chief Executive Officer and the other members of the board of directors or pursuant to the terms of our Stockholders Agreement.
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Other than pursuant to our Stockholders Agreement, we have not received director candidate recommendations from ourstockholders and we do not have a formal policy regarding consideration of such recommendations. However, any recommendations received from stockholders will be evaluated in the same manner that potential nominees suggested by board members, management or other parties are evaluated. We do not intend to treat stockholder recommendations in any manner different from other recommendations.
Our board of directors has not adopted a policy with respect to minimum qualifications for board members. With respect to each individual vacancy, the board of directors has determined the specific qualifications and skills required to fill that vacancy and to complement the existing qualifications and skills of the other members of the board of directors.
Historically, we have not engaged third parties to assist in identifying and evaluating potential nominees, but would do so in those situations where particular qualifications are required to fill a vacancy and the board of directors is not otherwise able to identify an appropriate pool of candidates.
Director Compensation
We do not compensate our board members for their participation on our board of directors.
Compensation Committee Interlocks and Insider Participation
None of our executive officers serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers who serve on our board or compensation committee.
Codes of Business Conduct and Ethics
Our board of directors has adopted a Code of Business Conduct and Ethics applicable to all of our officers, directors and employees including our chief executive officer, chief financial officer and other senior financial officers in accordance with applicable rules and regulations of the SEC and the American Stock Exchange.
Executive Compensation
The following table sets forth summary information concerning the cash and non-cash compensation we paid during the fiscal years ended December 31, 2001, 2002 and 2003 to our Chief Executive Officer and each of our other four most highly compensated executive officers whose
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compensation exceeded $100,000 for fiscal year 2003. We refer to these individuals as our named executive officers.
|
|
|
Long-Term Compensation Awards |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
Name and Principal Position |
Year |
Annual Compensation (Salary) |
Restricted Stock Awards ($)(1) |
Securities Underlying Options (#) |
||||||
Dave Schaeffer Chairman, President and Chief Executive Officer |
2003 2002 2001 |
$ |
250,000 250,000 250,000 |
$ |
6,377,823 |
478,700 |
||||
Helen Lee (2) Chief Financial Officer |
2003 2002 2001 |
250,000 248,750 220,000 |
911,262 |
100,000 |
||||||
Mark Schleifer Vice President, IP Engineering |
2003 2002 2001 |
208,000 208,000 208,000 |
105,113 |
3,796 |
||||||
Robert Beury, Jr. Chief Legal Officer |
2003 2002 2001 |
200,000 197,333 196,000 |
105,113 |
4,555 |
||||||
Bruce Wagner (3) Vice President of Sales |
2003 2002 2001 |
227,246 121,921 |
(3) |
151,849 |
|
2003 Option Information
We did not grant any options to our named executive officers during the year ended December 31, 2003, nor did any of them exercise any options during that year. Additionally, in October 2003 we closed a transaction with certain of our employees including the named executive officers pursuant to which they exchanged all of the options they then held for shares of our Series H preferred stock. We refer to this transaction as the offer to exchange. The offer to exchange is described in greater detail below under "ManagementEquity Plans."
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The shares of Series H preferred stock issued to our named executive officers pursuant to the offer to exchange, and the number of shares of common stock into which they will be converted immediately prior to the consummation of this offering, are set forth in the following table:
Named Executive Officer |
Shares of Series H preferred stock issued in offer to exchange |
Shares of common stock to be issued upon conversion of shares of Series H preferred stock |
||
---|---|---|---|---|
Dave Schaeffer | 37,801 | 1,453,885 | ||
Helen Lee (1) | 5,401 | 207,730 | ||
Mark Schleifer | 623 | 23,961 | ||
Robert Beury, Jr. | 623 | 23,961 | ||
Bruce Wagner (2) | 900 | 34,615 |
Employment Agreements
Dave Schaeffer Employment Agreement. Dave Schaeffer has an employment agreement that provides for a minimum annual salary of $250,000 for his services as Chief Executive Officer. He also receives all of our standard employee benefits and a life insurance policy with a death benefit of $2 million. If he is discharged without cause or resigns for good reason, he is entitled to a lump sum amount equal to his annual salary at the time and continuation of his benefits for one year. If he is subject to the excise tax imposed by Section 4999 of the Internal Revenue Code, he is entitled to additional payment to reimburse him for all taxes, up to a maximum additional payment of 20% of the amount subject to tax. The agreement also provides that failure to elect Mr. Schaeffer's designees to the board of directors, as provided in the Third Amended and Restated Stockholder Agreement, constitutes a material breach of his employment agreement. We expect that the stockholder agreement will terminate in connection with this offering. In the event of a change of control, 100% of his then unvested restricted stock and options will vest immediately.
Mark Schleifer Employment Agreement. Mark Schleifer's employment agreement provides for a minimum annual salary of $208,000 for his services as Vice President, IP Engineering. In the event that his employment with us is terminated without cause or constructively terminated without cause, the agreement entitles him to three months of salary and continuation of benefits for six months. In the event of a change of control the vesting of his restricted stock accelerates so that he will be 100% vested in not less than 12 months following the change of control. In the event of a change of control resulting in his termination without cause, 100% of his then restricted stock and options will vest immediately.
Robert Beury Employment Agreement. Robert Beury's employment agreement provides for a minimum annual salary of $196,000 for his services as Vice President and General Counsel. The agreement entitles him to six months of salary and six months of benefits in the event that his employment with us is terminated without cause or constructively terminated. In the event of a change of control the vesting of his restricted stock accelerates so that he will be 100% vested in not less than 12 months following the change of control. In the event of a change of control resulting in his termination without cause, 100% of his then restricted stock and options will vest immediately.
Equity Plans
2000 Equity Incentive Plan. In 1999 we adopted the 2000 Equity Incentive Plan. The principal purpose for the adoption of the 2000 Equity Incentive Plan was to attract, retain, and motivate selected officers, employees, consultants, and directors through the granting of stock-based compensation
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awards. The 2000 Equity Incentive Plan provides for a variety of compensation awards, including stock options, stock purchase rights and direct stock grants. Our board of directors, through the compensation committee, administers the 2000 Equity Incentive Plan with respect to all awards. The full board administers the 2000 Equity Incentive Plan with respect to options granted to independent directors, if any. Grants of equity compensation under the 2000 Equity Incentive Plan were made both to current and new officers, employees, consultants and directors based on each grantee's contributions the business as well as such grantee's anticipated contributions to our future growth and improvement. No options were granted to the named executive officers under the 2000 Equity Incentive Plan in 2003.
2003 Incentive Award Plan and Offer to Exchange. During the third quarter of 2003, we adopted the 2003 Incentive Award Plan. We believed that adoption of the 2003 Award Plan was necessary to permit us to continue to incent our employees, consultants and directors by granting restricted stock awards as part of their overall compensation. The decision to grant shares of restricted preferred stock under the 2003 Award Plan was made in order to allow our management and employees to share in the proceeds of our sale or other liquidation when the amount of the proceeds resulted in a distribution to preferred stockholders under the liquidation provisions of the preferred stock, but were not sufficient to result in distributions to holders of our common stock. We expect that this structure will incent our management and employees by providing them with the possibility of reaping an economic benefit in a greater number of scenarios than would be the case if the 2003 Award Plan provided only for common stock grants.
The compensation committee determined that each of our employees would be eligible to receive grants of Series H preferred stock under the 2003 Award Plan pursuant to an arrangement that we refer to as the offer to exchange. The number of shares granted to each employee pursuant to the offer to exchange was based on the number of options to purchase common stock granted to that employee under our 2000 Equity Incentive Plan, and in the case of our Chief Executive Officer, former Chief Financial Officer and our current Chief Financial Officer, the number of options and shares of restricted common stock held by such individuals. As a condition to participating in the offer to exchange, employees were required to relinquish all options to purchase our common stock, and in the case of our Chief Executive Officer, former Chief Financial Officer and our current Chief Financial Officer, options to purchase our common stock and the restricted common stock previously issued to them. Restrictions on transfer of shares of Series H preferred stock granted pursuant to the offer to exchange were removed with respect to 27% of the shares granted upon receipt of the shares and then in equal monthly installments over the subsequent 35 months.
2004 Incentive Award Plan. In 2004, we adopted our 2004 Incentive Award Plan. The 2004 Award Plan is intended to enhance and supplement the 2003 Award Plan and the awards made thereunder by broadening the types of awards that may be granted to employees and consultants and by providing for grants to directors. In addition to awards of restricted shares of Series H preferred stock, the 2004 Award Plan will provide us with the ability to award other equity-based incentive compensation, such as options to purchase shares of our Series H preferred stock and common stock, stock appreciation rights, dividend equivalent rights, performance awards, restricted stock units, deferred stock and stock payments to employees, consultants and directors.
The principal purpose for the adoption of the 2004 Award Plan is to promote the success of our business and enhance our value by linking the personal interests of employees, consultants and directors to our success and by providing these individuals with an incentive for outstanding performance. We believe that the 2004 Plan will also give us the flexibility to offer a variety of types of compensation and to remain competitive in recruiting and retaining qualified key personnel.
The following table sets forth information relating to grants of options that were made in the third quarter of 2004 pursuant to the 2004 Award Plan to:
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The dollar value set forth in the table assumes exercise of the options and conversion of the Series H preferred stock into common stock and is based on the closing price of our common stock on the American Stock Exchange on September 22, 2004. Mr. Schaeffer's options will fully vest 100% in the 30th month after grant. The options to our other officers and employees will vest with respect to 25% in 12 months from grant with the remaining 75% vesting in 36 equal monthly installments.
Name and Position |
Dollar Value ($) |
Number of Shares of Series H preferred stock Subject to Option |
|||
---|---|---|---|---|---|
Dave Schaeffer | $ | 3,807,694 | 15,000 | ||
Helen Lee (1) | | | |||
Mark Schleifer | 63,462 | 250 | |||
Robert Beury, Jr. | 88,846 | 350 | |||
Bruce Wagner (2) | | | |||
Other Executive Officers | 266,539 | 1,050 | |||
Non-Executive Officer Employee Group | 380,769 | 1,500 |
Award grants under the 2004 Award Plan were made in order to reward the grantees for their contributions in connection with the acquisition of our European network, the equity financing in connection with the acquisition and for their roles in our continued success. The size of the awards were determined on the basis of the magnitude of each grantee's contributions as well as such grantee's anticipated contributions to the growth and improvement of our business that we hope to experience in the future. Each share of restricted Series H preferred stock granted under the 2003 and 2004 Award Plans, or underlying options to purchase shares of our Series H preferred stock will be converted into approximately 381/2 shares of our common stock immediately prior to this offering.
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The following table provides summary information regarding the beneficial ownership of our outstanding capital stock as of September 15, 2004, after giving effect to the Reverse Stock Split and the Equity Conversion, but without giving effect to the underwriters' exercise of the over-allotment option, for:
Beneficial ownership of shares is determined under the rules of the SEC and generally includes any shares over which a person exercises sole or shared voting or investment power. Except as indicated by footnote, and subject to applicable community property laws, each person identified in the table possesses sole voting and investment power with respect to all shares of common stock held by them. Shares of common stock subject to options currently exercisable or exercisable within 60 days of September 15, 2004 and shares of restricted stock not subject to repurchase as of that date are deemed outstanding for calculating the percentage of outstanding shares of the person holding those options or shares of restricted stock, but are not deemed outstanding for calculating the percentage of any other person. Unless otherwise noted, the address for each director and executive officer is c/o Cogent Communications Group, Inc., 1015 31st Street, N.W., Washington D.C. 20007.
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Beneficial Ownership |
|||||||
---|---|---|---|---|---|---|---|---|
Name of Beneficial Owner |
Number of Shares Prior to this Offering |
Number of Shares After this Offering(12) |
Percentage Prior to this Offering |
Percentage After this Offering |
||||
Entities affiliated with Jerusalem Venture Partners Building One Mahla, Jerusalem 91487(1) |
4,931,631 | 17.7 | % | |||||
Entities affiliated with Oak Investment Partners IX, LP One Gorham Island Westport, CT 06880(3) |
3,965,045 |
14.2 |
% |
|||||
Entities affiliated with BNP Europe Telecom & Media Fund II, LP(5) | 3,874,768 | 13.9 | % | |||||
Entities affiliated with Worldview Technology Partners 435 Tasso Street, #120 Palo Alto, CA 94301(2) |
3,305,274 |
11.9 |
% |
|||||
Entities affiliated with BCP Capital (previously Broadview Capital Partners) One Maritime Plaza, Suite 2525 San Francisco, CA 94111 |
2,011,542 |
7.2 |
% |
|||||
Cisco Systems Capital Corporation(6) | 3,409,995 | 12.2 | % | |||||
Dave Schaeffer(7) | 1,028,750 | 3.7 | % | |||||
Erel Margalit(1) | 4,931,631 | 17.7 | % | |||||
Michael Carus(1) | 4,931,631 | 17.7 | % | |||||
Edward Glassmeyer(3) | 3,965,045 | 14.2 | % |
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Jean-Jacques Bertrand(5) | 3,874,768 | 13.9 | % | |||||
Timothy Weingarten(2) | 3,305,274 | 11.9 | % | |||||
Steven Brooks(4) | 2,011,542 | 7.2 | % | |||||
Mark Schleifer(8) | 13,500 | * | ||||||
Robert Beury, Jr.(9) | 13,500 | * | ||||||
R. Reed Harrison III | 675,236 | * | ||||||
Directors and executive officers as a group (14 persons)(11) | 19,218,314 | 69.0 | % |
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Our Headquarters Lease
We lease office space in Washington, D.C. from a partnership of which our Chairman and Chief Executive Officer, Dave Schaeffer, is the general partner. The annual rent for this space is approximately $369,000 and the lease expires August 31, 2005 with an option to renew. We believe that this lease agreement is on terms at least as favorable to us as could have been obtained from an unaffiliated third party.
Acquisitions
In connection with our acquisition of our European network, we acquired Symposium Gamma, Inc., a corporation owned by certain of our principal stockholders, which held the assets used to establish our network in France and Spain, and Symposium Omega, Inc., a corporation also owned by certain of our principal stockholders, which held the assets used to establish our network in Germany. Immediately prior to our acquisition of Symposium Gamma, it had acquired its network assets from Symposium, Inc., a corporation owned by our Chief Executive Officer David Schaeffer. These transactions are described in more detail under "Management's Discussion and Analysis of Financial Condition and Results of OperationsAcquisitionsAcquisition of European Network."
Stockholders Agreement
In connection with the acquisitions described above, the holders of Series F preferred stock, Series G preferred stock, Series I preferred stock, Series J preferred stock, Series K preferred stock and Series L preferred stock entered into a Fourth Amended and Restated Stockholders Agreement with us, which provides for, among other things, an agreement by the parties to vote shares of common stock held by them for our directors so as to elect as directors persons designated by certain of the parties to such agreement as well as the right to participate on a proportional basis in any of our future equity offerings. The parties to the Stockholders Agreement have informed us that they intend to terminate the Stockholders Agreement simultaneously with the completion of the offering and to enter into a new agreement that will set forth certain agreements with respect to the sale of common stock that they hold upon the expiration of the lock-up agreements that they have entered into and that are described in "UnderwritingLock-up Agreements."
Registration Rights Agreement
The holders of the Series F preferred stock, Series G preferred stock, Series I preferred stock, Series J preferred stock, Series K preferred stock and Series L preferred stock are parties to the Sixth Amended and Restated Registration Rights Agreement with us, which provides for, among other things, registration rights with respect to common stock issued to the parties to the agreement. The material terms of this agreement are described in more detail in "Shares Eligible for Future SaleRegistration Rights."
Employment Agreements
We have employment agreements with certain of our named executive officers as described in "Executive CompensationEmployment Agreements."
Cisco Systems Service Provider Letter Agreement
In connection with the Cisco recapitalization in July 2003, which is described in detail under "Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources," we entered into a Service Provider Letter Agreement with Cisco Systems pursuant to which we are required, until August 1, 2005, to make use of Cisco equipment for 80% of the hardware in our network. Any purchases we make to maintain this percentage would be on standard terms that we would expect to obtain from an unaffiliated third party.
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The following description of our capital stock is only a summary and is qualified in its entirety by reference to the actual terms and provisions of the capital stock contained in our Fifth Amended and Restated Certificate of Incorporation, which will become effective immediately prior to the consummation of this offering, and our bylaws, as they will be amended at the same time.
Our certificate of incorporation will authorize 45.0 million shares of common stock, par value $.001 per share and 10,000 shares of preferred stock, par value $.001 per share, the rights and preferences of which may be designated by the board of directors.
Our Common Stock
Voting Rights. The holders of our common stock are entitled to one vote per share on all matters submitted for action by the shareholders. There is no provision for cumulative voting with respect to the election of directors. Accordingly, a holder or group of holders of more than 50% of the shares of our common stock can, if it so chooses, elect all of our directors. In that event, the holders of the remaining shares will not be able to elect any directors.
Dividend Rights. All shares of our common stock are entitled to share equally in any dividends our board of directors may declare from legally available sources, subject to the terms of any then-outstanding preferred stock.
Liquidation Rights. Upon liquidation or dissolution of our company, whether voluntary or involuntary, all shares of our common stock are entitled to share equally in the assets available for distribution to shareholders after payment of all of our prior obligations, including any then-outstanding preferred stock.
Other Matters. The holders of our common stock have no preemptive or conversion rights, and our common stock is not subject to further calls or assessments by us. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of our common stock, including the common stock offered in this offering, are fully paid and non-assessable.
Registration Rights Agreement
The holders of the Series F preferred stock, Series G preferred stock, Series I preferred stock, Series J preferred stock, Series K preferred stock and Series L preferred stock are parties to a Sixth Amended and Restated Registration Rights Agreement with us, which provides for, among other things, registration rights with respect to common stock issued to the parties to the agreement. The material terms of this agreement are described in more detail in "Shares Eligible for Future SaleRegistration Rights."
Our Preferred Stock
The board of directors is authorized, subject to certain limitations prescribed by law, without further stockholder approval, to issue from time to time up to an aggregate of 10,000 shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series thereof, including the dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, including sinking fund provisions, redemption price or prices, liquidation preferences and the number of shares constituting any series or designations of such series. Although we have no present plans to issue any shares of preferred stock, these additional shares may be used for a variety of corporate purposes, including future public offerings, to raise additional capital or to facilitate acquisitions. One of the effects of the existence of unissued and undesignated preferred stock may be to enable our board of directors to
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issue shares to persons friendly to current management, which issuance could render more difficult or discourage an attempt to obtain control of our company by means of a merger, tender offer, proxy contest or otherwise, and thereby protect the continuity of our management and possibly deprive the stockholders of opportunities to sell their shares of common stock at prices higher than prevailing market prices.
Certain provisions of our Bylaws and Delaware General Corporation Law
We are subject to Section 203 of the Delaware general corporation law, an anti-takeover law. In general, Section 203 prohibits a publicly held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years following the date the person became an interested stockholder, unless the "business combination" or the transaction in which the person became an interested stockholder is approved in a prescribed manner. Generally, a "business combination" includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the interested stockholder. Generally, an "interested stockholder" is a person who, together with affiliates and associates, owns or within three years prior to the determination of interested stockholder status, did own, 15% or more of a corporation's voting stock. The existence of this provision may have an anti-takeover effect with respect to transactions not approved in advance by the board of directors, including discouraging attempts that might result in a premium over the market price for the shares of common stock held by stockholders.
Transfer Agent and Registrar
Registrar and Transfer Company has been appointed as the transfer agent and registrar for our common stock.
Listing
Our common stock is currently traded on the American Stock Exchange under the symbol "COI."
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UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
TO NON-UNITED STATES HOLDERS
The following is a summary of the material U.S. federal income tax consequences to non-U.S. holders of the ownership and disposition of our common stock, but does not purport to be a complete analysis of all the potential tax considerations relating thereto. This summary is based upon the provisions of the Internal Revenue Code of 1986, as amended, or the Code, Treasury regulations promulgated thereunder, administrative rulings and judicial decisions, all as of the date hereof. These authorities may be changed, possibly retroactively, so as to result in U.S. federal income tax consequences different from those set forth below. This summary is applicable only to non-U.S. holders who hold our common stock as a capital asset (generally, an asset held for investment purposes). We have not sought any ruling from the Internal Revenue Service (the "IRS"), with respect to the statements made and the conclusions reached in the following summary, and there can be no assurance that the IRS will agree with such statements and conclusions.
This summary also does not address the tax considerations arising under the laws of any foreign, state or local jurisdiction. In addition, this discussion does not address tax considerations applicable to an investor's particular circumstances or to investors that may be subject to special tax rules, including, without limitation:
In addition, if a partnership holds our common stock, the tax treatment of a partner generally will depend on the status of the partner and upon the activities of the partnership. Accordingly, partnerships which hold our common stock and partners in such partnerships should consult their tax advisors.
You are urged to consult your tax advisor with respect to the application of the U.S. federal income tax laws to your particular situation, as well as any tax consequences of the purchase, ownership and disposition of our common stock arising under the U.S. federal estate or gift tax rules or under the laws of any state, local, foreign or other taxing jurisdiction or under any applicable tax treaty.
Non-U.S. Holder Defined
For purposes of this discussion, you are a non-U.S. holder if you are a holder that, for U.S. federal income tax purposes, is not a U.S. person. For purposes of this discussion, you are a U.S. person if you are:
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Distributions
If distributions are made on shares of our common stock, those payments will constitute dividends for U.S. tax purposes to the extent paid from our current or accumulated earnings and profits, as determined under U.S. federal income tax principles. To the extent those distributions exceed both our current and our accumulated earnings and profits, they will constitute a return of capital and will first reduce your basis in our common stock, but not below zero, and then will be treated as gain from the sale of stock.
Any dividend paid to you generally will be subject to U.S. withholding tax either at a rate of 30% of the gross amount of the dividend or such lower rate as may be specified by an applicable tax treaty. In order to receive a reduced treaty rate, you must provide us with an IRS Form W-8BEN or other appropriate version of IRS Form W-8 certifying qualification for the reduced rate.
Dividends received by you that are effectively connected with your conduct of a U.S. trade or business (and, where a tax treaty applies, are attributable to a U.S. permanent establishment maintained by you) are exempt from such withholding tax. In order to obtain this exemption, you must provide us with an IRS Form W-8ECI properly certifying such exemption. Such effectively connected dividends, although not subject to withholding tax, are taxed at the same graduated rates applicable to U.S. persons, net of certain deductions and credits. In addition, if you are a corporate non-U.S. holder, dividends you receive that are effectively connected with your conduct of a U.S. trade or business may also be subject to a branch profits tax at a rate of 30% or such lower rate as may be specified by an applicable tax treaty.
If you are eligible for a reduced rate of withholding tax pursuant to a tax treaty, you may obtain a refund of any excess amounts currently withheld if you file an appropriate claim for refund with the IRS.
Gain on Disposition of Common Stock
You generally will not be required to pay U.S. federal income tax on any gain realized upon the sale or other disposition of our common stock unless:
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We believe that we are not currently and will not become a USRPHC. However, because the determination of whether we are a USRPHC depends on the fair market value of our U.S. real property relative to the fair market value of our other business assets, there can be no assurance that we will not become a USRPHC in the future. Even if we become a USRPHC, however, as long as our common stock is regularly traded on an established securities market, such common stock will be treated as U.S. real property interests only if you actually or constructively hold more than 5% of our common stock.
If you are a non-U.S. holder described in the first bullet above, you will be required to pay tax on the net gain derived from the sale under regular graduated U.S. federal income tax rates, and corporate non-U.S. holders described in the first bullet above may be subject to the branch profits tax at a 30% rate or such lower rate as may be specified by an applicable income tax treaty. If you are an individual non-U.S. holder described in the second bullet above, you will be required to pay a flat 30% tax on the gain derived from the sale, which tax may be offset by U.S. source capital losses. You should consult any applicable income tax treaties that may provide for different rules.
Backup Withholding and Information Reporting
Generally, we must report annually to the IRS the amount of dividends paid to you, your name and address, and the amount of tax withheld, if any. A similar report is sent to you. Pursuant to tax treaties or other agreements, the IRS may make its reports available to tax authorities in your country of residence.
Payments of dividends made to you will not be subject to backup withholding if you establish an exemption, for example by properly certifying your non-U.S. status on a Form W-8BEN or another appropriate version of Form W-8. Notwithstanding the foregoing, backup withholding at a rate of up to 28% may apply if either we or our paying agent has actual knowledge, or reason to know, that you are a U.S. person.
Payments of the proceeds from a disposition of our common stock effected outside the United States by a non-U.S. holder made by or through a foreign office of a broker generally will not be subject to information reporting or backup withholding. However, information reporting (but not backup withholding) will apply to such a payment if the broker is a U.S. person, a controlled foreign corporation for U.S. federal income tax purposes, a foreign person 50% or more of whose gross income is effectively connected with a U.S. trade or business for a specified three-year period, or a foreign partnership with certain connections with the United States, unless the broker has documentary evidence in its records that the beneficial owner is a non-U.S. holder and specified conditions are met or an exemption is otherwise established.
Payments of the proceeds from a disposition of our common stock by a non-U.S. holder made by or through the U.S. office of a broker is generally subject to information reporting and backup withholding unless the non-U.S. holder certifies as to its non-U.S. holder status under penalties of perjury or otherwise establishes an exemption from information reporting and backup withholding.
Backup withholding is not an additional tax. Rather, the U.S. income tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund or credit may be obtained, provided that the required information is furnished to the IRS in a timely manner.
75
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of our common stock in the public market could adversely affect the market price of our common stock. Furthermore, because only a limited number of shares will be available for sale shortly after this offering due to the contractual and legal restrictions on resale described below, sales of substantial amounts of our common stock in the public market after the restrictions lapse, or the perception that such sales could occur, could adversely affect the prevailing market price and our ability to raise capital in the future.
Upon the closing of this offering, we will have outstanding an aggregate of shares of common stock. Of the outstanding shares, the shares sold in this offering will be freely tradable without restriction or further registration under the Securities Act, except that any shares held by our "affiliates," as that term is defined under Rule 144 of the Securities Act, may be sold only in compliance with the limitations described below. The remaining shares of common stock will be deemed "restricted securities" as defined under Rule 144. Restricted securities may be sold in the public market only in a transaction registered under the Securities Act of 1933 (for example pursuant to the Registration Rights summarized below) or if they qualify for an exemption from registration under Rule 144 or 144(k) under the Securities Act, which rules are summarized below, or another exemption under the Securities Act applies.
Additionally, as described in "UnderwritingLock-up Agreements," we have agreed, along with each of our directors and executive officers and the holders of our preferred stock (which will be converted into shares of our common stock upon consummation of this offering), with limited exceptions, without the prior written consent of Jefferies & Company, Inc. on behalf of the underwriters, not to transfer or dispose of, directly of indirectly, any shares of common stock or any securities convertible into or exercisable or exchangeable for shares of common stock. As a result of these "lock-up" agreements, the restricted shares will be available for sale in the public market, subject to eligibility for sale under Rules 144 or 144(k) or in a registered transaction and subject to the release from lock-up obligations, one year after the date of this prospectus, or 180 days after the date of this prospectus if sold pursuant to a public offering underwritten on a firm commitment basis.
Rule 144
In general, under Rule 144, as currently in effect, a person who owns shares that were acquired from us or an affiliate of ours at least one year prior to the proposed sale is entitled to sell, within any 90-day period, upon expiration of any lock-up agreement to which he or she is a party, a number of shares that does not exceed the greater of:
Sales under Rule 144 are also subject to certain manner of sale provisions and notice requirements and to the availability of current public information about us. Rule 144 also provides that our affiliates who sell shares of our common stock that are not restricted shares must nonetheless comply with the same restrictions applicable to restricted shares, other than the holding period requirement.
Rule 144(k)
Under Rule 144(k), a person who is not deemed to be, or to have been, one of our affiliates for purposes of the Securities Act at any time during the 90 days preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, including in some circumstances the
76
holding period of a prior owner, is entitled to sell the shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144.
Registration Rights
Certain of our preferred stock holders who are subject to the lockup agreements entered into a restated registration rights agreement with us, which provides for, among other things, registration rights with respect to common stock held by such parties. Pursuant to the registration rights agreement, these parties may require us to register upon demand the sale of their shares of common stock on up to three occasions. This requirement is called a demand registration. We are required to pay all registration expenses in connection with any demand registration effected pursuant to a registration right. In addition, if we propose to register the sale of any of our common stock under the Securities Act, whether for our own account or otherwise, those stockholders are entitled to notice of the registration and are entitled to include, subject to certain exceptions, their shares of common stock in that registration with all registration expenses paid by us. Notwithstanding the foregoing, pursuant to their obligations under the lock-up agreements, these parties will unable to exercise a registration right prior to one year after the date of this prospectus.
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General
Under the terms and subject to the conditions contained in an underwriting agreement dated the date of this prospectus, the underwriters named below, for whom Jefferies & Company, Inc. is acting as representative, have severally agreed to purchase, and we have agreed to sell to them, the numbers of shares of common stock indicated below:
Name |
Number of Shares |
||
---|---|---|---|
Jefferies & Company, Inc. | |||
CIBC World Markets | |||
Friedman, Billings, Ramsey & Co., Inc. | |||
Total |
The underwriting agreement provides that the obligations of the several underwriters to pay for and accept delivery of the shares of common stock offered by this prospectus are subject to the approval of certain legal matters by their counsel and to certain other conditions. The underwriters are obligated to take and pay for all of the shares of common stock offered by this prospectus, other than those shares being offered directly to the participating stockholders, if any such shares are taken. However, the underwriters are not required to take or pay for the shares covered by the underwriters' over-allotment option described below. The underwriting agreement also provides that in the event of a default by an underwriter, in some circumstances, the purchasing commitments of non-defaulting underwriters may be increased or the underwriting agreement may be terminated.
The underwriters initially propose to offer part of the shares directly to the public at the public offering price listed on the cover page of this prospectus and part to certain dealers at a price that represents a concession not in excess of $ a share less than the public offering price. The underwriters may allow, and those dealers may re-allow, a discount not in excess of $ to other dealers. The offering price and other selling terms may from time to time be varied by the representative of the underwriters. The price of the common stock to be sold in the offering will be negotiated between us and the underwriters, taking into account the Reverse Stock Split, the Equity Conversion, prevailing market conditions, our historical performance and estimates of our business and earnings potential.
Over-Allotment Option
We have granted to the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to an aggregate of additional shares of common stock at the public offering price listed on the cover page of this prospectus, less underwriting discounts and commissions. The underwriters may exercise this option solely for the purpose of covering over-allotments, if any, made in connection with the offering of the shares of common stock offered by this prospectus. To the extent the option is exercised, each underwriter will become obligated, subject to various conditions, to purchase about the same percentage of the additional shares of common stock as the number listed next to the name of that underwriter in the preceding table bears to the total number of shares of common stock listed next to the names of all underwriters in the preceding table.
Compensation and Expenses
The following table shows the per share and total underwriting discounts and commissions to be paid to the underwriters by us. These amounts are shown assuming both no exercise and full exercise of the underwriters' over-allotment option to purchase additional shares of common stock.
|
Paid by Us |
Paid by the Selling Stockholders |
|||||||
---|---|---|---|---|---|---|---|---|---|
|
Without Over-Allotment |
With Over-Allotment |
Without Over-Allotment |
With Over-Allotment |
|||||
Per share | |||||||||
Total |
78
We estimate that the total expenses of this offering, excluding the underwriting discounts and commissions, will be approximately $3.3 million which will be paid by us.
Lock-up Agreements and Registration Rights
We have agreed, along with each of our directors and executive officers and the holders of our preferred stock (which will be converted into shares of our common stock upon consummation of this offering), with limited exceptions, without the prior written consent of Jefferies & Company, Inc. on behalf of the underwriters, not to offer, sell, pledge or otherwise transfer or dispose of, directly of indirectly, any shares of common stock or any securities convertible into or exercisable or exchangeable for shares of common stock. Jefferies & Company, Inc. has no intention of consenting to any early waiver of this "lock-up" agreement. The Company will be released from this "lock-up" agreement 180 days after the date of this prospectus.
The shares subject to these lock-up agreements held by our directors, our executive officers and our preferred stockholders will be released from the agreements one year after the date of this prospectus. Additionally, 180 days after the date of this prospectus, shares subject to the lock-up agreements will be released from the lock-up agreements if sold pursuant to a public offering registered under the Securities Act and underwritten on a firm commitment basis.
The lock-up agreements do not apply to:
Stabilization, Short Positions and Penalty Bids
In connection with the offering the underwriters may engage in stabilizing transactions, over-allotment transactions, syndicate covering transactions and penalty bids in accordance with Regulation M under the Securities Exchange Act of 1934.
79
shares than could be covered by the over-allotment option, a naked short position, the position can only be closed out by buying shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there could be downward pressure on the price of shares in the open market after pricing that could adversely affect investors who purchase shares in the offering.
These stabilizing transactions, syndicate covering transactions and penalty bids may have the effect of raising or maintaining the market price of our common stock or preventing or retarding a decline in the market price of the common stock. As a result, the price of our common stock may be higher than the price that might otherwise exist in the open market. These transactions may be commenced and discontinued at any time. Our common stock is listed on the American Stock Exchange under the symbol of "COI."
Passive Market Making
In connection with this offering, certain underwriters and selling group members, if any, who are market makers may engage in passive market making transactions in our common in accordance with Rule 103 of Regulation M under the Securities Exchange Act of 1934, as amended. In general, a passive market maker must display its bid at a price not in excess of the highest independent bid for such security; if all independent bids are lowered below the passive market maker's bid, however, such bid must then be lowered when certain purchase limits are exceeded.
Electronic Distribution
A prospectus in electronic format may be made available on Internet sites or through other online services maintained by one or more of the underwriters and/or selling group members participating in this offering, or by their affiliates. In those cases, prospective investors may view offering terms online and, depending upon the particular underwriter or selling group member, prospective investors may be allowed to place orders online. The underwriters may allocate a specific number of shares for sale to online brokerage account holders. Any such allocation for online distributions will be made by the representative on the same basis as other allocations.
Other than the prospectus in electronic format, information contained in any other web site maintained by an underwriter or selling group member is not part of this prospectus or the registration statement of which this prospectus forms a part, has not been approved and/or endorsed by us and should not be relied on by investors in deciding whether to purchase any shares of common stock. The underwriters and selling group members are not responsible for information contained in web sites that they do not maintain.
United Kingdom Compliance
Each underwriter has agreed that:
80
Indemnification
The Company has agreed to indemnify the underwriters, and the underwriters have agreed to indemnify the Company against certain liabilities, including liabilities under the Securities Act of 1933.
Other
It is expected that delivery of the shares of common stock will be made to investors on or about , 2004.
We are offering, at the public offering price, an aggregate of shares of our common stock to certain of our existing stockholders. These entities have indicated an interest in purchasing an aggregate of shares of our common stock. We are offering these shares directly to these participating stockholders and not through underwriters or any brokers or dealers. The consummation of the offering made by this prospectus is conditioned on the consummation of the sale of shares to our participating stockholders, and the consummation of the sale of shares to our participating stockholders is conditioned on the consummation of the offering of shares made by this prospectus.
From time to time in the ordinary course of their respective businesses, some of the underwriters and their affiliates may in the future engage in commercial banking and/or investment banking transactions with us and our affiliates.
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The validity of the shares of common stock offered hereby will be passed upon for us by Latham & Watkins LLP, Washington, D.C. Various legal matters relating to this offering will be passed upon for the underwriters by Mayer, Brown, Rowe & Maw LLP, New York, NY.
The consolidated financial statements of Cogent Communications Group, Inc. at December 31, 2003 and 2002, and for each of the years then ended, appearing in this prospectus and registration statement have been audited by Ernst & Young LLP, independent registered public accounting firm, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing.
The consolidated financial statements of Firstmark Communications Participations S.à. r.l. at December 31, 2003 and 2002, and for each of the years then ended, appearing on this prospectus and registration statement have been audited by Ernst & Young SA, independent registered public accounting firm, as set forth in their report thereon (which contains an explanatory paragraph describing conditions that raise substantial doubt about Firstmark Communications' ability to continue as a going concern as described in Note 1 to the consolidated financial statements) appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing.
Our consolidated financial statements for the year ended December 31, 2001 and for Allied Riser Communications Corporation for the years ended December 31, 2001, 2000 and 1999 appearing in this prospectus and registration statement, were audited by Arthur Andersen LLP. After reasonable efforts, we have not been able to obtain the consent of Arthur Andersen LLP to the incorporation by reference into such this registration statement of Arthur Andersen LLP's audit report regarding such financial statements. Accordingly, Arthur Andersen LLP will not be liable to investors under Section 11(a) of the Securities Act because it has not consented to being named as an expert in this registration statement. Therefore, such lack of consent may limit the recovery by investors from Arthur Andersen LLP.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration statement under the Securities Act of 1933, as amended, referred to as the Securities Act, with respect to the shares of our common stock offered by this prospectus. This prospectus, filed as a part of the registration statement, does not contain all of the information set forth in the registration statement or the exhibits and schedules thereto as permitted by the rules and regulations of the SEC. For further information about us and our common stock, you should refer to the registration statement. This prospectus summarizes provisions that we consider material of certain contracts and other documents to which we refer you. Because the summaries may not contain all of the information that you may find important, you should review the full text of those documents. We have included copies of those documents as exhibits to the registration statement.
We are currently subject to the periodic reporting and other requirements of the Securities Exchange Act of 1934. You may read and copy any document we file or have filed with the SEC, including the registration statement of which this prospectus is a part and the exhibits thereto, may be inspected, without charge, and copies may be obtained at prescribed rates, at the SEC's Public Reference Room at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The registration statement and other information filed by us with the SEC are also available at the SEC's Internet site at www.sec.gov. You may request copies of the filing, at no cost, by telephone at (202) 295-4200 or by mail at Cogent Communications Group, Inc., 1015 31st Street N.W., Washington, D.C. 20007.
82
Index to Consolidated Financial Statements
|
|
||||
---|---|---|---|---|---|
Cogent Communications Group, Inc. | |||||
Unaudited Interim Condensed Consolidated Financial Statements | |||||
Condensed Consolidated Balance Sheets as of December 31, 2003 and June 30, 2004 (unaudited) | F-2 | ||||
Condensed Consolidated Statements of Operations for the three months ended June 30, 2003 and June 30, 2004 (unaudited) | F-3 | ||||
Condensed Consolidated Statements of Operations for the six months ended June 30, 2003 and June 30, 2004 (unaudited) | F-4 | ||||
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and June 30, 2004 (unaudited) | F-5 | ||||
Notes to Interim Condensed Consolidated Financial Statements (unaudited) | F-6 | ||||
Audited Consolidated Financial Statements | |||||
Report of Independent Registered Public Accounting Firm | F-24 | ||||
Report of Independent Public Accountants | F-25 | ||||
Consolidated Balance Sheets as of December 31, 2002 and 2003 | F-26 | ||||
Consolidated Statements of Operations for the years ended December 31, 2001, December 31, 2002 and December 31, 2003 | F-27 | ||||
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2001, December 31, 2002 and December 31, 2003 | F-28 | ||||
Consolidated Statements of Cash Flows for the years ended December 31, 2001, December 31, 2002 and December 31, 2003 | F-30 | ||||
Notes to Consolidated Financial Statements | F-32 | ||||
FirstMark Communications Participations S.à r.l. and subsidiaries |
|||||
Audited Consolidated Financial Statements | |||||
Report of Independent Registered Public Accounting Firm | F-57 | ||||
Consolidated Balance Sheets as of December 31, 2003 and 2002 | F-58 | ||||
Consolidated Statements of Operations For the Years Ended December 31, 2003 and 2002 | F-60 | ||||
Consolidated Statements of Changes in Stockholders' Equity For the Years Ended December 31, 2003 and 2002 | F-61 | ||||
Consolidated Statements of Cash Flows For the Years Ended December 31, 2003 and 2002 | F-62 | ||||
Notes to the Consolidated Financial Statements | F-63 | ||||
Allied Riser Communications Corporation |
|||||
Audited Consolidated Financial Statements | |||||
Report of Independent Public Accountants | F-83 | ||||
Consolidated Balance Sheets as of December 31, 2001 and 2000 | F-84 | ||||
Consolidated Statements of Income (loss) For the Years Ended December 31, 2001, 2000, and 1999 | F-85 | ||||
Consolidated Statements of Changes in Shareholders' Equity (Deficit) For the Years Ended December 31, 2001, 2000, and 1999 | F-86 | ||||
Consolidated Statements of Cash Flows For the Years Ended December 31, 2001, 2000, and 1999 | F-87 | ||||
Notes to the Consolidated Financial Statements | F-88 |
F-1
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2003 AND JUNE 30, 2004
(IN THOUSANDS, EXCEPT SHARE DATA)
|
December 31, 2003 |
June 30, 2004 |
||||||
---|---|---|---|---|---|---|---|---|
|
|
(Unaudited) |
||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 7,875 | $ | 13,000 | ||||
Short term investments ($753 and $740 restricted, respectively) | 4,115 | 1,839 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $2,868 and $3,109, respectively | 5,066 | 6,754 | ||||||
Accounts receivable related party | | 1,214 | ||||||
Prepaid expenses and other current assets | 905 | 4,434 | ||||||
Total current assets | 17,961 | 27,241 | ||||||
Property and equipment: | ||||||||
Property and equipment | 400,097 | 457,527 | ||||||
Accumulated depreciation and amortization | (85,691 | ) | (110,884 | ) | ||||
Total property and equipment, net | 314,406 | 346,643 | ||||||
Intangible assets: | ||||||||
Intangible assets | 26,780 | 27,809 | ||||||
Accumulated amortization | (18,671 | ) | (23,582 | ) | ||||
Total intangible assets, net | 8,109 | 4,227 | ||||||
Other assets ($1,608 and $1,333 restricted, respectively) | 3,964 | 5,199 | ||||||
Total assets | $ | 344,440 | $ | 383,310 | ||||
Liabilities and stockholders' equity |
||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 7,296 | $ | 11,036 | ||||
Accounts payable related party | | 1,322 | ||||||
Accrued liabilities | 7,885 | 12,313 | ||||||
Current maturities, capital lease obligations | 3,646 | 6,049 | ||||||
Total current liabilities | 18,827 | 30,720 | ||||||
Amended and Restated Cisco Note | 17,842 | 17,842 | ||||||
Convertible subordinated notes, net of discount of $6,084 and $5,606 | 4,107 | 4,585 | ||||||
Capital lease obligations, net of current | 58,107 | 102,464 | ||||||
Other long-term liabilities | 803 | 1,621 | ||||||
Total liabilities | 99,686 | 157,232 | ||||||
Commitments and contingencies: |
||||||||
Stockholders' equity: | ||||||||
Convertible preferred stock, Series F, $0.001 par value; 11,000 shares authorized, issued, and outstanding; liquidation preference of $29,100 | 10,904 | 10,904 | ||||||
Convertible preferred stock, Series G, $0.001 par value; 41,030 shares authorized, issued and outstanding; liquidation preference of $123,090 | 40,787 | 40,787 | ||||||
Convertible preferred stock, Series H, $0.001 par value; 84,001 shares authorized; 53,372 and 52,023 shares issued and outstanding, respectively; liquidation preference of $7,960 | 45,990 | 41,015 | ||||||
Convertible preferred stock, Series I, $0.001 par value; 3,000 shares authorized, 2,575 shares issued and outstanding at June 30, 2004; liquidation preference of $7,725 | | 2,545 | ||||||
Convertible preferred stock, Series J, $0.001 par value; 3,891 shares authorized, issued and outstanding at June 30, 2004; liquidation preference of $58,365 | | 19,421 | ||||||
Common stock, $0.001 par value; 30,000,000 shares authorized; 653,567 and 802,142 shares outstanding, respectively | 1 | 1 | ||||||
Additional paid-in capital | 232,474 | 235,801 | ||||||
Deferred compensation | (32,680 | ) | (24,955 | ) | ||||
Stock purchase warrants | 764 | 764 | ||||||
Treasury stock, 61,462 shares | (90 | ) | (90 | ) | ||||
Accumulated other comprehensive income | 628 | 304 | ||||||
Accumulated deficit | (54,024 | ) | (100,419 | ) | ||||
Total stockholders' equity | 244,754 | 226,078 | ||||||
Total liabilities and stockholders' equity | $ | 344,440 | $ | 383,310 | ||||
The accompanying notes are an integral part of these condensed consolidated statements.
F-2
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30, 2003 AND JUNE 30, 2004
(IN THOUSANDS EXCEPT SHARE AND PER SHARE
AMOUNTS)
|
Three Months Ended June 30, 2003 |
Three Months Ended June 30, 2004 |
|||||
---|---|---|---|---|---|---|---|
|
(Unaudited) |
(Unaudited) |
|||||
Net service revenue (none and $503 from related party, respectively) | $ | 15,519 | $ | 20,387 | |||
Operating expenses: | |||||||
Network operations (including $51 and $213 of amortization of deferred compensation, respectively, and none and $316 to related party, respectively, exclusive of amounts shown separately) | 12,282 | 13,486 | |||||
Selling, general, and administrative (including $761 and $2,832 of amortization of deferred compensation, respectively, and $1,718 and $1,192 of allowance for doubtful accounts, respectively) | 7,978 | 12,370 | |||||
Depreciation and amortization | 11,827 | 13,749 | |||||
Total operating expenses | 32,087 | 39,605 | |||||
Operating loss | (16,568 | ) | (19,218 | ) | |||
Interest income and other | 315 | 120 | |||||
Interest expense | (6,543 | ) | (3,127 | ) | |||
Net loss | $ | (22,796 | ) | $ | (22,225 | ) | |
Net loss per common share: |
|||||||
Basic and diluted net loss per common share | $ | (130.87 | ) | $ | (29.51 | ) | |
Weighted-average common shares basic and diluted | 174,192 | 753,130 | |||||
The accompanying notes are an integral part of these condensed consolidated statements.
F-3
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND JUNE 30, 2004
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
|
Six Months Ended June 30, 2003 |
Six Months Ended June 30, 2004 |
||||||
---|---|---|---|---|---|---|---|---|
|
(Unaudited) |
(Unaudited) |
||||||
Net service revenue (none and $1,115 from related party, respectively) | $ | 29,751 | $ | 41,332 | ||||
Operating expenses: | ||||||||
Network operations (including $108 and $425 of amortization of deferred compensation, respectively, and none and $1,366 to related party, respectively, exclusive of amounts shown separately) | 23,021 | 29,433 | ||||||
Selling, general, and administrative (including $1,440 and $5,652 of amortization of deferred compensation, respectively, and $2,211 and $2,020 of allowance for doubtful accounts, respectively) | 15,142 | 24,771 | ||||||
Depreciation and amortization | 23,038 | 28,285 | ||||||
Total operating expenses | 61,201 | 82,489 | ||||||
Operating loss | (31,450 | ) | (41,157 | ) | ||||
Gain Allied Riser note exchange | 24,802 | | ||||||
Interest income and other | 710 | 1,132 | ||||||
Interest expense | (14,944 | ) | (6,370 | ) | ||||
Net loss | $ | (20,882 | ) | $ | (46,395 | ) | ||
Beneficial conversion charge |
|
(22,028 |
) |
|||||
Net loss applicable to common stock | $ | (20,882 | ) | $ | (68,423 | ) | ||
Net loss per common share: | ||||||||
Basic and diluted net loss per common share | $ | (119.88 | ) | $ | (65.09 | ) | ||
Beneficial conversion charge | | (30.90 | ) | |||||
Basic and diluted net loss per common share applicable to common stock | $ | (119.88 | ) | $ | (95.99 | ) | ||
Weighted-average common shares basic and diluted | 174,192 | 712,794 | ||||||
The accompanying notes are an integral part of these condensed consolidated statements.
F-4
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND JUNE 30, 2004
(IN THOUSANDS)
|
Six Months Ended June 30, 2003 |
Six Months Ended June 30, 2004 |
||||||
---|---|---|---|---|---|---|---|---|
|
(Unaudited) |
(Unaudited) |
||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (20,882 | ) | $ | (46,395 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Gain Allied Riser note exchange | (24,802 | ) | | |||||
Gain sale of warrant | | (843 | ) | |||||
Depreciation and amortization | 23,038 | 28,285 | ||||||
Amortization of debt costs | 1,164 | | ||||||
Amortization of debt discount convertible notes | 1,432 | 478 | ||||||
Amortization of deferred compensation | 1,548 | 6,077 | ||||||
Loss on equipment sale | | 106 | ||||||
Changes in assets and liabilities, net of acquisitions: | ||||||||
Accounts receivable | 678 | 4,884 | ||||||
Accounts receivable related party | | (1,233 | ) | |||||
Prepaid expenses and other current assets | (699 | ) | 2,146 | |||||
Other assets | 1,827 | 189 | ||||||
Accounts payable related party | | 1,343 | ||||||
Accounts payable, accrued and other liabilities | (2,067 | ) | (12,666 | ) | ||||
Net cash used in operating activities | (18,763 | ) | (17,629 | ) | ||||
Cash flows from investing activities: |
||||||||
Purchases of property and equipment | (18,297 | ) | (4,038 | ) | ||||
Sales of short term investments | 2,739 | 2,276 | ||||||
Purchases of intangible assets | (700 | ) | (161 | ) | ||||
Proceeds from other assets acquired Firstmark acquisition | | 596 | ||||||
Cash acquired Firstmark acquisition | | 2,159 | ||||||
Cash acquired Gamma acquisition | | 2,545 | ||||||
Cash acquired Omega acquisition | | 19,421 | ||||||
Proceeds from sale of equipment | | 276 | ||||||
Proceeds from sale of warrant | | 3,406 | ||||||
Net cash (used in) provided by investing activities | (16,258 | ) | 26,480 | |||||
Cash flows from financing activities: |
||||||||
Borrowings under Cisco credit facility | 8,005 | | ||||||
Repayment of advances from LNG Holdings related party | | (1,227 | ) | |||||
Exchange agreement payment Allied Riser notes | (4,998 | ) | | |||||
Repayments of capital lease obligations | (1,609 | ) | (2,081 | ) | ||||
Net cash provided by (used in) financing activities | 1,398 | (3,308 | ) | |||||
Effect of exchange rate changes on cash | 564 | (418 | ) | |||||
Net (decrease) increase in cash and cash equivalents | (33,059 | ) | 5,125 | |||||
Cash and cash equivalents, beginning of period | 39,314 | 7,875 | ||||||
Cash and cash equivalents, end of period | $ | 6,255 | $ | 13,000 | ||||
Supplemental disclosures of cash flow information: |
||||||||
Non-cash financing activities Capital lease obligations incurred | $ | 9,294 | $ | 65 | ||||
Borrowing under credit facility for payment of loan costs and interest | $ | 4,502 | ||||||
Issuance of Series I preferred stock for Gamma common stock | $ | 2,575 | ||||||
Issuance of Series J preferred stock for Omega common stock | $ | 19,454 | ||||||
Symposium Gamma Merger Firstmark acquisition |
||||||||
Fair value of assets acquired | $ | 155,468 | ||||||
Negative goodwill | (77,232 | ) | ||||||
Less: valuation of Series I preferred stock issued | (2,575 | ) | ||||||
Fair value of liabilities assumed | $ | 75,661 | ||||||
The accompanying notes are an integral part of these condensed consolidated statements.
F-5
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003 and 2004
(unaudited)
1. Description of business:
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 primarily Internet access to businesses located in North America and in Western Europe. 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 Company's high-speed Internet access service is delivered to its customers over a fiber-optic network. The Company's network is dedicated primarily to Internet Protocol data traffic. Since the Company's April 2002 acquisition of certain assets of PSINet, Inc. ("PSINet"), in addition to its high-speed Internet access service offering, the Company added a more traditional Internet service offering, 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 customers that purchase this service. The Company provides high-speed Internet access to businesses, universities, operators of Internet web sites, and other Internet service providers in North America and Europe.
Merger with Symposium Omega
On March 30, 2004, Symposium Omega, Inc., ("Omega") a Delaware corporation and related party, merged with a subsidiary of the Company (Note 11). 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 convertible preferred stock to the shareholders of Omega in exchange for all of the outstanding common stock of Omega. The accounting for the merger resulted in the Company recording cash of approximately $19.5 million and issuing Series J convertible preferred stock. The acquisition of the German fiber optic network will be accounted for when the purchase closes. This Series J convertible preferred stock is convertible into approximately 6.0 million shares of the Company's common stock. 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 requires a payment 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. Approximately 0.2 million euro of the 2.3 million euro was paid through the second quarter of 2004. It is anticipated that the remaining 2.1 million euro payment will be made in 2004. The Company is in the process of integrating this German network into its existing European networks and is offering point-to-point transport, transit services and its North American product set in Germany.
Merger with Symposium Gamma, Inc. and Acquisition 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 (Note11). 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
F-6
and new investors and in January 2004, acquired Firstmark for $1. The merger 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 convertible participating preferred stock. This Series I convertible preferred stock is convertible into approximately 0.8 million shares of the Company's common stock. The Company is supporting Firstmark's products including point-to-point transport and transit services in over 40 markets and approximately 20 data centers across Western Europe. The Company has also introduced in Western Europe a new set of products and services based on the Company's current North American product set.
Capital Account Adjustments Upon Offering
All share and per share amounts have been retroactively adjusted to give effect to a one-for-twenty reverse stock split to be adopted before the effectiveness of the offering contemplated by this prospectus. In addition, the convertible preferred stock will convert into shares of common stock upon the closing of the offering contemplated by this prospectus.
Basis of presentation
The accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the unaudited condensed consolidated financial statements reflect all normal recurring adjustments that the Company considers necessary for the fair presentation of its results of operations and cash flows for the interim periods covered, and of the financial position of the Company at the date of the interim condensed consolidated balance sheet. Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. The operating results for interim periods are not necessarily indicative of the operating results for the entire year. While the Company believes that the disclosures made are adequate to not make the information misleading, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included elsewhere in this prospectus.
The accompanying unaudited consolidated financial statements include all wholly owned subsidiaries. All inter-company accounts and activity have been eliminated.
Business risk
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's business plan is dependent upon the Company's ability to increase 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, access to capital, 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's ability to retain and attract key employees, and the Company's ability to manage its growth, among other factors. Although management believes that the Company will successfully mitigate these risks, management cannot give assurances that it will be able to do so or that the Company will ever operate profitably.
F-7
International operations
The Company began recognizing revenue from operations in Canada through its wholly owned subsidiary, ARC Canada effective with the closing of the Allied Riser merger on February 4, 2002. All revenue is reported in United States dollars. Revenue for ARC Canada for the three months ended June 30, 2003 and June 30, 2004 was approximately $1.4 million and $1.5 million, respectively. Revenue for ARC Canada for the six months ended June 30, 2003 and June 30, 2004 was approximately $2.7 million and $2.9 million, respectively. ARC Canada's total consolidated assets were approximately $11.8 million at December 31, 2003 and $11.1 million at June 30, 2004.
The Company began recognizing revenue from operations in Europe through its wholly owned subsidiary, Symposium Gamma, Inc. effective with the January 5, 2004 acquisition of Firstmark. All revenue is reported in United States dollars. Revenue for Firstmark for the three and six months ended June 30, 2004 was approximately $5.0 million and $10.6 million, respectively. Firstmark's total consolidated assets were approximately $61.1 million at June 30, 2004.
Financial instruments
The Company is party to letters of credit totaling $2.0 million as of June 30, 2004. Securing these letters of credit are restricted investments totaling $2.1 million that are included in short-term investments and other assets. No claims have been made against these financial instruments.
At December 31, 2003 and June 30, 2004, the carrying amount of cash and cash equivalents, short-term investments, accounts receivable, accounts payable, and accrued expenses approximated fair value because of the short maturity of these instruments. The Allied Riser convertible subordinated notes remaining after the note exchange discussed in Note 7, have a face value of $10.2 million. These notes were recorded at their fair value of approximately $2.9 million at the merger date when they were trading at $280 per $1,000. The discount is being accreted to interest expense through the maturity date.
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 typically provided under month-to-month or annual contracts that are 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 collection is probable. The probability of collection is determined by an analysis of credit history for new customers and historical payment patterns for existing customers. Service discounts and incentives related to telecommunication services are recorded as a reduction of revenue when granted. Fees billed in connection with customer installations and other non-refundable upfront charges are deferred and recognized ratably over the longer of the estimated customer life or contract term determined by a historical analysis of customer retention, generally one year.
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 monthly by evaluating general factors, such as the length of time individual receivables are past due, historical collection experience, the economic and competitive environment, changes in the credit worthiness of its customers and any unprocessed customer cancellations. The Company believes that its established valuation allowances are adequate as of December 31, 2003 and June 30, 2004. If circumstances relating to specific customers change or economic conditions worsen such that the Company's past
F-8
collection experience and assessment of the economic environment are no longer relevant, the Company's estimate of the recoverability of its accounts receivable could be further reduced.
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 zero 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.
Foreign Currency
The functional currency of ARC Canada is the Canadian dollar. The functional currency of Firstmark is the euro. The consolidated financial statements of ARC Canada, and Firstmark, are translated into U.S. dollars using the period-end rates of exchange for assets and liabilities and average rates of exchange for revenues and expenses. Gains and losses on translation of the accounts of the Company's non-U.S. operations are accumulated and reported as a component of other comprehensive income 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 (amounts in thousands).
|
Three Months Ended June 30, 2003 |
Three Months Ended June 30, 2004 |
Six Months Ended June 30, 2003 |
Six Months Ended June 30, 2004 |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net loss applicable to common stock | $ | (22,796 | ) | $ | (22,225 | ) | $ | (20,882 | ) | $ | (68,423 | ) | |
Currency translation | 344 | (201 | ) | 564 | (324 | ) | |||||||
Comprehensive loss | $ | (22,452 | ) | $ | (22,426 | ) | $ | (20,318 | ) | $ | (68,747 | ) | |
Long-lived assets
The Company'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 Accounting Standards No. 144, "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'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 believes that no such impairment existed in accordance with SFAS No. 144 as of December 31, 2003 or June 30, 2004. In the event there are changes in the planned use of the Company's long-term assets or the Company's expected future undiscounted cash flows are reduced significantly, the Company's assessment of its ability to recover the carrying value of these assets under SFAS No. 144 could 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 to SFAS No. 144 exists. However, because of the significant difficulties confronting the telecommunications industry, management believes that the current fair value of its long-lived assets including its network
F-9
assets and IRU's are significantly below the amounts the Company originally paid 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 accepted in the United States 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 could differ from those estimates.
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") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. 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. The Company has adopted the disclosure only requirements of SFAS No. 123, "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 based method of accounting described in SFAS No. 123 had been applied to employee stock option grants and restricted shares. 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):
|
Three Months Ended June 30, 2003 |
Three Months Ended June 30, 2004 |
Six Months Ended June 30, 2003 |
Six Months Ended June 30, 2004 |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net loss, as reported | $ | (22,796 | ) | $ | (22,225 | ) | $ | (20,882 | ) | $ | (46,395 | ) | ||
Add: stock-based employee compensation expense included in reported net loss, net of related tax effects | 812 | 3,045 | 1,548 | 6,077 | ||||||||||
Deduct: stock-based employee compensation expense determined under fair value based method, net of related tax effects | (984 | ) | (3,045 | ) | (2,480 | ) | (6,077 | ) | ||||||
Pro forma-net loss | $ | (22,968 | ) | $ | (22,225 | ) | $ | (21,814 | ) | $ | (46,395 | ) | ||
Net loss per share as reported-basic and diluted | $ | (130.87 | ) | $ | (29.51 | ) | $ | (119.88 | ) | $ | (65.09 | ) | ||
Pro forma net income loss per share-basic and diluted | $ | (131.85 | ) | $ | (29.51 | ) | $ | (125.23 | ) | $ | (65.09 | ) | ||
The weighted-average per share grant date fair value of options granted was $12.40 for the three months ended June 30, 2003 and $10.60 for the six months ended June 30, 2003. The fair value of these options was estimated at the date of grant with the following assumptions for the three months ended June 30, 2003an average risk-free rate of 3.5 percent, a dividend yield of 0 percent, an expected life of 5.0 years and an expected volatility of 163 percent and for the six months ended June 30, 2003an average risk-free rate of 3.5 percent, a dividend yield of 0 percent, an expected life of 5.0 years and an expected volatility of 240 percent. There were no options granted in the six months ended June 30, 2004. The weighted-average per share grant date fair value of Series H convertible preferred shares granted to employees in the three months ended March 31, 2004 and June 30, 2004
F-10
was $1,332.35 and $1,205.32 respectively. The fair value was determined using the as converted number of common shares times the trading price of the Company's common stock on the date of grant. Each share of Series H convertible preferred stock converts into approximately 38.5 shares of common stock. Stock-based employee compensation for the three and six months ended June 30, 2004 was equal to the amount that would have been recorded under the fair value method since the Series H preferred shares were valued using the trading price of the Company's common stock on the grant date and there were no stock options that vested during the period. During the six months ended June 30, 2004 employees converted 3,963 shares of Series H preferred stock into approximately 0.1 million shares of common stock.
Basic and diluted net loss per common share
Net loss per share is presented in accordance with the provisions of SFAS No. 128 "Earnings per 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-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 when their effect would be anti-dilutive.
For the three and six months ended June 30, 2004 the following securities were not included in the computation of earnings per share as they are anti-dilutive: preferred stock convertible into approximately 24.8 million shares of common stock, options to purchase 6,080 shares of common stock at a weighted-average exercise price of $9.00 per share, warrants for 5,200 shares of common stock at a weighted average exercise price of $226.00 per share and 1,062 shares of common stock issuable on the conversion of the Allied Riser convertible subordinated notes. For the three and six months ended June 30, 2003, approximately 1,000 shares of common stock issuable on the conversion of the Allied Riser convertible subordinated notes were not included in the computation of earnings per share as they are anti-dilutive.
Asset retirement obligations
In accordance with SFAS No. 143, "Accounting for Asset Retirement Obligations," the fair value of a liability for an asset retirement obligation is recognized in the period 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 passage of time by applying an interest method of allocation to the amount of the liability at the beginning of the period. The interest rate used to measure that change is the credit-adjusted risk-free rate that existed when the liability was initially measured.
Recent Accounting Pronouncements
In March 2004, the FASB ratified the consensuses reached by Emerging Issues Task Force in Issue No. 03-06, "Participating Securities and the Two-Class Method under FASB Statement No. 128" ("EITF 03-06"). EITF 03-06 clarifies the definitional issues surrounding participating securities and requires companies to restate prior earnings per share amounts for comparative purposes upon adoption. The Company adopted the provisions of EITF 03-06 in the second quarter of 2004, and the Company has restated its previously disclosed basic earnings per share amounts to include its participating securities in basic earnings per share when dilutive. As a result, basic income per share
F-11
available to common shareholders decreased from $11.00 to $2.78 for the quarter ended March 31, 2003, from $271.80 to $12.64 for the quarter ended September 30, 2003, and from $229.18 to $11.18 for the year ended December 31, 2003. The adoption of EITF 03-06 did not have an impact on any of the periods presented, herein as the inclusion of participating securities in basic earnings per share for these periods is anti-dilutive.
2. Acquisitions:
The merger with Firstmark was recorded in the accompanying financial statements under the purchase method of accounting. The Firstmark purchase price allocation is preliminary and further refinements may be made if certain assumed accounts payable and accrued liabilities do not result in cash payments. During the second quarter of 2004 the assumed liabilities were reduced by approximately $0.6 million resulting in an increase in negative goodwill. The operating results related to the merger with Firstmark has been included in the consolidated statements of operations from the date of acquisition. The Firstmark acquisition closed on January 5, 2004.
The purchase price of Firstmark was approximately $78.2 million which includes the fair value of the Company's Series I preferred stock of $2.6 million and assumed liabilities of $75.7 million. The fair value of assets acquired was approximately $155.5 million which then gave rise to negative goodwill of approximately $77.3 million. Negative goodwill was allocated to long-lived assets, resulting in recorded assets acquired of $78.2 million.
The following table summarizes the recorded values of the assets acquired and the liabilities assumed (in thousands).
|
Firstmark |
||
---|---|---|---|
Current assets | $ | 17,374 | |
Property and equipment | 55,862 | ||
Intangible assets | 855 | ||
Other assets | 4,145 | ||
Total assets acquired | $ | 78,236 | |
Current liabilities | 25,118 | ||
Other long term liabilities | 860 | ||
Capital lease obligations | 49,683 | ||
Total liabilities assumed | 75,661 | ||
Net assets acquired | $ | 2,575 | |
The intangible assets acquired in the Firstmark acquisition were customer contracts and licenses. The Firstmark customer contracts ($0.4 million) are being amortized over two years and licenses ($0.4 million) over the terms of the licenses. The Firstmark acquisition was assumed to occur on January 1, 2004 since the results of Firstmark for the period from January 1, 2004 to January 4, 2004 were not material. Pro forma combined results for Omega are not included below since the Omega acquisition was not considered the acquisition of a business, because Omega had no customers, employees or associated revenues. If the Firstmark acquisition had taken place at the beginning of 2003, the unaudited pro forma combined results of the Company for the six months ended June 30, 2003 would have been as follows (amounts in thousands, except per share amounts).
|
Six Months Ended June 30, 2003 |
|||
---|---|---|---|---|
Revenue | $ | 43,226 | ||
Net loss | (47,323 | ) | ||
Net loss per share basic and diluted | $ | (271.67 | ) |
In management'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 Firstmark acquisition had been effective at the beginning of 2003.
F-12
Property and equipment consisted of the following (in thousands):
|
December 31, 2003 |
June 30, 2004 |
||||||
---|---|---|---|---|---|---|---|---|
Owned assets: | ||||||||
Network equipment | $ | 186,204 | $ | 210,308 | ||||
Software | 7,482 | 7,572 | ||||||
Office and other equipment | 4,120 | 14,316 | ||||||
Leasehold improvements | 50,387 | 52,386 | ||||||
System infrastructure | 32,643 | 33,396 | ||||||
Construction in progress | 988 | 181 | ||||||
281,824 | 318,159 | |||||||
Less Accumulated depreciation and amortization | (72,762 | ) | (93,885 | ) | ||||
209,062 | 224,274 | |||||||
Assets under capital leases: | ||||||||
IRUs | 118,273 | 139,368 | ||||||
Less Accumulated depreciation and amortization | (12,929 | ) | (16,999 | ) | ||||
105,344 | 122,369 | |||||||
Property and equipment, net | $ | 314,406 | $ | 346,643 | ||||
Depreciation and amortization expense related to property and equipment was $9.3 million and $11.5 million for the three months ended June 30, 2003 and June 30, 2004, respectively, and was $18.3 million and $23.3 million for the six months ended June 30, 2003 and June 30, 2004, respectively
Capitalized labor and related costs
For the three months ended June 30, 2003 and June 30, 2004, the Company capitalized salaries and related benefits of $0.8 million and $0.4 million, respectively. For the six months ended June 30, 2003 and June 30, 2004, the Company capitalized salaries and related benefits of $1.7 million and $0.8 million, respectively.
4. Accrued liabilities:
Accrued liabilities consist of the following (in thousands):
|
December 31, 2003 |
June 30, 2004 |
||||
---|---|---|---|---|---|---|
General operating expenditures | $ | 4,541 | $ | 5,366 | ||
Payroll and benefits | 419 | 540 | ||||
Litigation settlement accruals | 400 | 195 | ||||
Taxes | 1,584 | 2,564 | ||||
Interest | 455 | 2,303 | ||||
Deferred revenue | 486 | 1,345 | ||||
Total | $ | 7,885 | $ | 12,313 | ||
F-13
5. Intangible assets:
Intangible assets consist of the following (in thousands):
|
December 31, 2003 |
June 30, 2004 |
|||||
---|---|---|---|---|---|---|---|
Customer contracts | $ | 8,145 | $ | 8,593 | |||
Peering arrangements | 16,440 | 16,440 | |||||
Trade name | 1,764 | 1,764 | |||||
Other | | 167 | |||||
Licenses | | 414 | |||||
Non compete agreements | 431 | 431 | |||||
Total | 26,780 | 27,809 | |||||
Less accumulated amortization | (18,671 | ) | (23,582 | ) | |||
Intangible assets, net | $ | 8,109 | $ | 4,227 | |||
Amortization expense for the three months ended June 30, 2003 and June 30, 2004 was approximately $2.5 million and $2.2 million, respectively. Amortization expense for the six months ended June 30, 2003 and June 30, 2004 was approximately $4.8 million and $4.9 million, respectively. Future amortization expense related to intangible assets is $3.8 million, $0.2 million and $0.2 million for the twelve-month periods ending June 30, 2005, 2006, and 2007, respectively.
6. Other assets:
Other assets consist of the following (in thousands):
|
December 31, 2003 |
June 30, 2004 |
||||
---|---|---|---|---|---|---|
Prepaid expenses | $ | 378 | $ | 317 | ||
Deposits | 3,419 | 4,466 | ||||
Deferred public offering costs | | 416 | ||||
Other | 167 | | ||||
Total | $ | 3,964 | $ | 5,199 | ||
In the Firstmark acquisition the Company obtained warrants to purchase 506,600 ordinary shares (originally 5,066 shares which were subsequently split at a ratio of 1 to 100) of Floware Wireless Systems Ltd. a company listed on the NASDAQ since September 2000. The warrants were exercisable through March 2005, at a price of $3.89 per share and were valued at the acquisition date at a fair market value of approximately $2.6 million under the Black-Scholes method of valuation. In 2001 Floware Wireless Systems Ltd. ("Floware") merged into Breezecom Ltd. ("Breezecom"). Breezecom subsequently changed its name to Alvarion Ltd. In January 2004, the Company exercised the warrants and sold the related securities for proceeds of approximately $3.4 million resulting in a gain of approximately $0.8 million recorded during the six months ended June 30, 2004 and is included as a component of interest and other income in the accompanying condensed consolidated financial statements.
7. Long-term debt:
Restructuring and Amended and Restated Credit Agreement
In March 2000, Cogent entered into a $280 million credit facility with Cisco Capital. In March 2001, the credit facility was increased to $310 million and in October 2001 the agreement was
F-14
increased to $409 million. Immediately prior to the restructuring of the credit facility on July 31, 2003, the Company was indebted under the Cisco credit facility for a total of $269.1 million ($262.8 million of principal and $6.3 million of accrued but unpaid interest). On June 12, 2003, the Company's Board of Directors approved a transaction with Cisco Systems, Inc. ("Cisco") and Cisco Capital that restructured the Company's indebtedness to Cisco Capital.
In order to restructure the Company's credit facility, the Company, Cisco and Cisco Capital entered into an agreement (the "Exchange Agreement") which, among other things, cancelled the principal amount and accrued interest and returned warrants exercisable for the purchase approximately 40,000 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 a $17.0 million amended and restated promissory note (the "Amended and Restated Cisco Note") under an Amended and Restated Credit Agreement. 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. The debt restructuring 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. Under the Purchase Agreement the Company's outstanding Series A, B, C, D and E participating convertible preferred stock ("Existing Preferred Stock") were converted into approximately 0.5 million shares of common stock.
On July 31, 2003, the Company, Cisco Capital, Cisco and the Investors closed on the Exchange Agreement and the Purchase Agreement.
Under the Amended and Restated Credit Agreement, 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 all 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 Amended and Restated Cisco Note is to be repaid in three installments. Interest is not payable, and does not accrue for the first 30 months, unless the Company defaults. 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 Company 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.
F-15
Future maturities of principal and estimated future interest under the Amended and Restated Cisco Note are as follows (in thousands):
For the year ending June 30, |
|
||
---|---|---|---|
2005 | $ | | |
2006 | 7,234 | ||
2007 | 5,444 | ||
2008 | 5,164 | ||
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 June 15, 2007 (the "Notes"). At the closing of the merger between Allied Riser and the Company in February 2002, approximately $117.0 million of the Notes were outstanding.
In January 2003, the Company, Allied Riser and the holders of approximately $106.7 million in face value of 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 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 the Company 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 the Notes since the December 15, 2002 interest payment, all future interest payment obligations on the Notes and settled the note holder litigation.
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 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 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 our Series C preferred stock which represented the Company's most recent equity transaction for cash.
The terms of the remaining $10.2 million of Notes were not impacted by these transactions and they 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 accreted to interest expense through the maturity date. The Notes are convertible at the option of the holders into approximately 1,000 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
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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.
8. Commitments and contingencies:
Capital leases-Fiber lease agreements
The Company has entered into various lease agreements with fiber providers for dark fiber primarily under 15-25 year IRUs. Once the Company has accepted the related fiber route, if the lease meets the criteria for treatment as a capital lease it is 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 June 30, |
|
|||
---|---|---|---|---|
2005 | $ | 16,204 | ||
2006 | 14,898 | |||
2007 | 13,291 | |||
2008 | 13,030 | |||
2009 | 11,251 | |||
Thereafter | 108,583 | |||
Total minimum lease obligations | 177,257 | |||
Less-amounts representing interest | (68,744 | ) | ||
Present value of minimum lease obligations | 108,513 | |||
Current maturities | (6,049 | ) | ||
Capital lease obligations, net of current maturities | $ | 102,464 | ||
Fiber Leases and Construction Commitments
Certain of the Company's agreements for the construction of building laterals and for the leasing of metro fiber rings and lateral fiber include minimum specified commitments. The future commitment under these arrangements was approximately $3.7 million at June 30, 2004.
Current and Potential Litigation
In May 2004 the Company settled a dispute with the former landlord of one of its subsidiaries, Allied Riser Operations Corporation, in Dallas, Texas for a payment by the Company of $0.6 million. The settlement terminated the lawsuit and resolved the dispute with respect to the termination of the lease that was the subject of the lawsuit.
The Company generally accrues for the amounts invoiced by its providers of telecommunications services. Liabilities for telecommunications disputed costs are generally reduced when the vendor acknowledges the reduction in its invoice and the credit is granted. In 2002, one telecommunications 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. Another vender has invoiced the Company for approximately $0.6 million that it is disputing. The Company is also involved in a dispute over intercompany services provided by and to Lambdanet Germany, a sister company of Firstmark's French subsidiaryLNF and Firstmark's Spanish subsidiaryLNE (See Note 11). The Company intends to vigorously defend its position related to these charges and feels that it has adequately reserved for the potential liability.
In 2003, a counterclaim was filed against the Company by a former employee in state court in California. The former employee asserted primarily that additional commissions were due to the
F-17
employee. The Company had filed a claim against this employee for breach of contract among other claims. A judgment was awarded and the Company has appealed this decision. The Company has recorded a liability for the estimated net loss under this judgment.
The Company has been made aware of several other companies in its own and in other industries that use the word "Cogent" in their corporate names. One company has informed the Company that it believes the Company's use of the name "Cogent" infringes on its intellectual property rights in that name. If such a challenge is successful, the Company could be required to change its name and lose the goodwill associated with the Cogent name in its markets. Management does not believe such a challenge, if successful, would have a material impact on the Company's business, financial condition or results of operations.
In December 2003 five former employees of the Company's Spanish subsidiary filed claims related to their termination of employment. The initial rulings of the Spanish court have supported the Company's position. The Company intends to continue to vigorously defend its position related to these charges and feels that it has adequately reserved for the potential liability.
The Company is involved in other legal proceedings in the normal course of business which management does not believe will have a material impact on the Company's financial condition.
Operating leases 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. Future minimum annual commitments under these arrangements are as follows (in thousands):
For the year ending June 30, |
|
||
---|---|---|---|
2005 | $ | 20,425 | |
2006 | 17,367 | ||
2007 | 14,767 | ||
2008 | 10,922 | ||
2009 | 8,745 | ||
Thereafter | 33,190 | ||
$ | 105,416 | ||
Rent expense, net of sublease income, for the three months ended June 30, 2003 and June 30, 2004 was approximately $0.6 million and $2.1 million, respectively. Rent expense, net of sublease income, for the six months ended June 30, 2003 and June 30, 2004 was approximately $1.1 million and $3.9 million, respectively. The Company has subleased certain office space and facilities. Future minimum payments under these sublease agreements are approximately $0.9 million, $0.7 million, $0.3 million, $0.2 million and $0.1 million for the years ending June 30, 2005 through June 30, 2009, respectively.
Maintenance and fiber lease agreements
The Company pays monthly fees for maintenance of its fiber optic network. 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 from various providers under contracts that range from month-to-month to five year terms.
F-18
Future minimum obligations related to these arrangements are as follows (in thousands):
Year ending June 30, |
|
||
---|---|---|---|
2005 | $ | 5,718 | |
2006 | 4,518 | ||
2007 | 3,856 | ||
2008 | 3,928 | ||
2009 | 3,884 | ||
Thereafter | 46,191 | ||
$ | 68,095 | ||
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 due to the possibility of acquiring certain LNG assets. 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 of approximately $0.2 million for the estimated fair value of this obligation and believes that the maximum loss exposure is limited to the as converted value of its Series I preferred stock.
LambdaNet Communications Deutschland, AG ("Lambdanet Germany")
The Company attempted to acquire Lambdanet Germany, but was unable to reach agreement with Lambdanet Germany's bank creditors. Firstmark has made use of Lambdanet Germany's facilities to complete communications circuits into Germany and has also depended on Lambdanet Germany for network operations support, billing and other services. The Company has begun the process of fully separating the operations of Firstmark from Lambdanet Germany but this process is not complete and there may be disruptions as this process proceeds.
9. Stockholders' equity:
In June 2003, the Company's board of directors and shareholders approved an amended and restated charter that increased the number of authorized shares of the Company's common stock from 1.0 million shares to 19.8 million 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. In April 2004, the Company's board of directors and shareholders approved an amended and restated charter that increased the number of authorized shares of the Company's common stock from 19.8 million shares to 30.0 million shares and increased the shares of undesignated preferred stock from 120,000 shares to 170,000 shares.
On July 31, 2003 and in connection with the Company' restructuring of its debt with Cisco Capital, all of the Company's Existing Preferred Stock was converted into approximately 10.8 million shares of common stock. At the same time the Company issued 11,000 shares of Series F preferred stock to Cisco Capital under 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 January 2004, Symposium Gamma Inc. ("Gamma") merged with a subsidiary of the Company. Under the merger agreement all of the issued and outstanding shares of Gamma common stock were
F-19
converted into 2,575 shares of the Company's Series I convertible participating preferred stock and the Company became Gamma and Firstmark's sole shareholder.
On March 30, 2004, Symposium Omega, Inc., ("Omega") a Delaware corporation merged with a subsidiary of the Company. Prior to the merger Omega had raised approximately $19.5 million in cash and acquired the rights to acquire a German fiber optic network. 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.
Each share of the Series F preferred stock, Series G preferred stock, Series H preferred stock, Series I preferred stock and Series J preferred stock (collectively, the "New Preferred") may be converted into shares of common stock at the election of its holder at any time. The Series F, Series G, Series I and Series J preferred stock are convertible into 3.4 million shares, 12.7 million shares, 0.8 million shares, and 6.0 million shares of the Company's common stock, respectively. The 84,001 authorized shares of Series H preferred stock are convertible into 3.2 million shares of the Company's common stock. The New Preferred will be automatically converted into common stock, at the then applicable conversion rate in the event of an underwritten public offering of shares of the Company at 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 subject 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 of shares of common stock then issuable upon conversion of such shares. The consent of holders of a majority of the outstanding Series F preferred stock is required to declare or pay any dividend on the common or the preferred stock of the Company, and the consent of the holders of 80% of the series of the Series G preferred stock, the Series I preferred stock and Series J preferred stock voting together as a class is required prior to an underwritten public offering 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 $50 million.
In the event of any dissolution, liquidation, or winding up of the Company, at least $29.1 million, $123.1 million, $8.0 million, $7.7 million and $58.4 million will be paid in cash to the holders of the Series F, G, H, I and J preferred stock, respectively, before any payment is made to the holders of the Company's common stock.
Offer to exchangeSeries H Preferred Stock and 2003 Incentive Award Plan
In September 2003, the Compensation Committee (the "Committee") 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. 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 under the Company's 2003 Incentive Award Plan. Under the offer, the Company recorded a deferred compensation charge of approximately $46.1 million in the fourth quarter of 2003. The Company also granted additional shares of Series H preferred to certain new employees resulting in an additional deferred compensation charge of approximately $1.1 million in 2003 and $2.4 million in the six months ended June 30, 2004. Deferred compensation is being amortized over the vesting period of the Series H preferred stock. 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 and for grants to newly hired employees; the shares vest 25% after one year with the remaining shares vesting ratably over three years. Compensation expense related to Series H preferred stock was approximately $16.4 million for the year ended December 31, 2003 and $6.1 million for the six months ended June 30, 2004. When an employee terminates prior to full vesting, the total remaining
F-20
deferred compensation charge is reduced, the employee retains their vested shares and the employees' unvested shares are returned to the plan.
In April 2004, the Company's board of directors and shareholders approved an amendment to the Company's 2003 Incentive Award Plan to increase the shares of Series H preferred stock available for grant under the plan from 54,001 to 84,001 shares. In May 2004, the Company's board of directors approved the Company's 2004 Incentive Award Plan under which the Company may make additional awards from the available shares of Series H preferred stock.
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.
Beneficial Conversion Charges
Beneficial conversion charges of $2.5 million and $19.5 million were recorded on January 5, 2004 and March 30, 2004, respectively, since the price per common share at which the Series I and Series J convertible preferred stock convert into at issuance were less than the quoted trading price of the Company's common stock on that date.
10. Segment information:
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company operates as one operating segment. Below are the Company's net revenues and long lived assets by geographic theater (in thousands):
|
Three Months Ended June 30, 2003 |
Three Months Ended June 30, 2004 |
Six Months Ended June 30, 2003 |
Six Months Ended June 30, 2004 |
||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Net Revenues | ||||||||||||
North America | $ | 15,519 | $ | 15,372 | $ | 29,751 | $ | 30,731 | ||||
Europe | | 5,015 | | 10,601 | ||||||||
Total | $ | 15,519 | $ | 20,387 | $ | 29,751 | $ | 41,332 | ||||
|
December 31, 2003 |
June 30, 2004 |
||||
---|---|---|---|---|---|---|
Long lived assets, net | ||||||
North America | $ | 322,515 | $ | 301,110 | ||
Europe | | 49,760 | ||||
Total | $ | 322,515 | $ | 350,870 | ||
11. Related party:
Office lease
The Company's headquarters is located in an office building owned by an entity controlled by the Company's Chief Executive Officer. The Company paid monthly rent to this entity of approximately $30,000 during 2003 and 2004.
F-21
Symposium, Inc.
In the third quarter of 2003, the Company became aware that LNG might be available for purchase. LNG and its operating subsidiaries operated a European telecommunications network and were on the verge of insolvency. The Company initially determined that it did not want to acquire the entire LNG operations at that time. However, the Company was interested in certain aspects of the LNG businesses and, given the Company's history of acquiring troubled assets, reconsidered and undertook further discussions with the owners of LNG with a view towards some type of transaction. The owners of LNG rejected any proposal other than a transaction in which they could transfer their entire ownership in LNG to a new owner. In order to prevent LNG from liquidating and to preserve the Company's ability to structure an acceptable acquisition, in November 2003, the Company's Chief Executive Officer formed and became the sole stockholder of Symposium, which acquired a 90% interest in LNG in return for the indemnification and release of the former owners from any liabilities associated with LNG and the commitment on the part of Symposium to cause at least $2 million to be invested in the LNG subsidiaries. No cash payment was made to the former owners of LNG. Because Symposium did not have to make a cash payment for the interest in LNG, it did not receive any investment from the Company's Chief Executive Officer or from any other investors. Currently, LNG's remaining subsidiaries hold assets related to their former telecommunications operations. The Company's Chief Executive Officer has informed the Company that he is considering selling the remaining assets of LNG and winding up its business.
Symposium Gamma, Inc.
Symposium Gamma Inc., ("Gamma") is a Delaware corporation that was created as part of the Firstmark acquisition structure described below. Gamma was formed by BNP Paribas, a stockholder of LNG, and certain of the Company's existing stockholders who initially capitalized Gamma with approximately $2.5 million of cash. BNP controlled the board of directors of Gamma and owned 50% of the capital stock of Gamma after its initial capitalization. Gamma was formed as an acquisition vehicle that would (a) allow the Company to demonstrate to LNG's creditors the identifiable cash for use in its restructuring of Firstmark and (b) allow the investors in Gamma to maintain control of their cash during the period prior to the closing of the acquisition. In connection with the Firstmark acquisition, Gamma was merged with and into a subsidiary of the Company and all of its outstanding capital stock was converted into shares of the Company's Series I preferred stock.
Symposium Omega, Inc.
Symposium Omega Inc., ("Omega") is a Delaware corporation that was created in order to enable the acquisition of the German operations of LNG for approximately 2.3 million euros. Omega was formed by BNP Paribas, a stockholder of LNG, and certain of the Company's existing stockholders who initially capitalized Omega with approximately $19.5 million of cash. BNP controlled the board of directors of Omega and owned 50% of the capital stock of Omega after its initial capitalization. Omega was formed as an acquisition vehicle that would (a) allow the Company to demonstrate to LNG's creditors the identifiable cash for use in its restructuring of the German operations of LNG and (b) allow the investors in Omega to maintain control of their cash during the period prior to the closing of the acquisition. Because a satisfactory agreement for a restructuring could not be reached with the creditors of the German operations of LNG, Omega used the cash contributed at its initial capitalization to acquire an alternate German network operation. In connection with the acquisition of the German fiber optic network, Omega was merged with and into a subsidiary of the Company and all of its outstanding capital stock was converted into shares of the Company's Series J preferred stock.
LNG Holdings S.A. and Firstmark Acquisition
In November 2003, Symposium acquired approximately 90% of the stock of LNG Holdings S.A. ("LNG") from certain of LNG's former stockholders. These stockholders received no cash
F-22
consideration from either Symposium or the Company's Chief Executive Officer in connection with the sale of their LNG stock. Rather, Symposium agreed with these stockholders that it would cause at least $2 million to be invested in LNG's subsidiary LambdaNet France, and Symposium and the Company agreed that they would indemnify the selling stockholders for certain liabilities associated with their prior ownership of LNG or with the transaction.
In January 2004, LNG transferred its interest in its wholly owned subsidiary Firstmark Communications Participations S.á r.l. ("Firstmark") to Gamma, in return for $1 and a commitment by Gamma to invest at least $2 million in the operations of Firstmark's French operating subsidiaryLNF. In January 2004, Gamma transferred $2.5 million to LNF and, by so doing, fulfilled its commitment to LNG. Also in January 2004, 215.1 million euros of Firstmark's total of 216.1 million euros of indebtedness to its previous parent LNG, and an additional 4.9 million euros owed to LNG were assigned to Gamma at their fair market value of one euro in connection with Gamma's acquisition of Firstmark. Thereafter, Gamma was merged with an into a subsidiary of the Company in exchange for shares of the Company's Series I preferred stock. Prior to the Company's acquisition of Gamma, and advanced as part of the Gamma merger, LNG transferred 1 million euros to LNF. LNF repaid the 1 million euros to LNG in March 2004. Accordingly, 215.1 million euros of the total 216.1 million euros of the debt obligation and 4.9 million euros of the other amounts payable have been eliminated in the consolidation of these financial statements.
Firstmark's subsidiaries provide network services and in turn utilize 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 LNG from November 2003 until April 2004 when Lambdanet Germany was sold to an unrelated party. During the three and six months ended June 30, 2004, Firstmark recorded revenue of 0.4 million euros ($0.5 million) and 0.9 million euros ($1.1 million), respectively, from Lambdanet Germany and network costs of 0.3 million euros ($0.3 million) and 1.1 million euros ($1.4 million), respectively, under the network sharing agreement. As of June 30, 2004 Firstmark had recorded net amounts due from Lambdanet Germany of 1.0 million euros and net amounts due to Lambdanet Germany of 1.1 million euros. These amounts are reflected as amounts due from related party ($1.2 million) and amounts due to related party ($1.3 million) in the accompanying condensed consolidated June 30, 2004 balance sheet. The Company is currently in negotiations with the new owner of Lambdanet Germany over the terms of settling these amounts and the network sharing agreement.
12. Subsequent Events:
On August 12, 2004, the Company merged with UFO Group, Inc. (UFO Group). The Company issued 2,600 shares of its newly authorized Series K convertible preferred stock in exchange for the outstanding shares of UFO Group. The Series K preferred stock converts into approximately 0.8 million shares of the Company's common stock and has rights and privileges similar to the Company's Series I preferred stock. Prior to the merger, UFO Group had acquired the majority of the assets of Unlimited Fiber Optics, Inc. (UFO). UFO's customer base is comprised of data service customers and its network is comprised of fiber optic facilities located in San Francisco, Los Angeles and Chicago. UFO billed its customers approximately $0.4 million for its July 2003 services. The acquired assets included net cash of approximately $2.0 million, all of UFO's customer contracts, customer accounts receivable and certain network equipment. Assumed liabilities include certain vendor relationships and accounts payable. The Company intends to integrate these acquired assets into its operations and onto its broadband network.
In July 2004, LNF re-located its Paris headquarters. The estimated net present value of the remaining lease obligation, net of estimated sub lease income, is approximately $1.3 million and will be recorded as a restructuring charge in July 2004.
F-23
Report of Independent Registered Public Accounting Firm
Cogent Communications Group, Inc. Board of Directors:
We have audited the accompanying consolidated balance sheets of Cogent Communications Group, Inc. and subsidiaries (the "Company") as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements 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 before the restatement adjustment described in Note 1.
We conducted our audits 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 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, 2003 and 2002, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
As described above, the financial statements of Cogent Communications Group, Inc. as of December 31, 2001, and for the year then ended were audited by other auditors who have ceased operations. As described in Note 1, in 2004, the Company's Board of Directors approved a one-for-twenty reverse stock split, and all references to number of shares and per share information in the financial statements have been adjusted to reflect the reverse stock split on a retroactive basis. We audited the adjustments that were applied to restate the number of shares and per share information reflected in the 2001 financial statements. Our procedures include (a) agreeing the authorization of the one-for-twenty reverse stock split to the Company's underlying records obtained from management, and (b) testing the mathematical accuracy of the restated number of shares, basic and diluted earnings per share and other applicable disclosures such as stock options. In our opinion, such adjustments are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 2001 financial statements of the Company other than with respect to such adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 2001 financial statements taken as a whole.
Ernst & Young LLP
McLean,
VA
March 2, 2004, except for 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, and except for
the paragraph under "Capital Account Adjustments Upon Offering" in Note 1, as to which the date is October , 2004.
The foregoing report is in the form that will be signed upon the completion of the restatement of capital accounts described in the paragraph under "Capital Account Adjustments Upon Offering" in Note 1 to the financial statements.
/s/ Ernst & Young LLP
McLean,
VA
September 27, 2004
F-24
This is a copy of the audit report previously issued by Arthur Andersen LLP in connection with 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 registration statement. 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 sheets of Cogent Communications Group, Inc. (a Delaware corporation), and Subsidiaries (together the Company) as of December 31, 2000 and 2001, and the related consolidated statements 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 responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
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.
ARTHUR ANDERSEN LLP
Vienna,
Virginia
March 1, 2002 (except with respect to the matters discussed in
Note 14, as to which the date is March 27, 2002)
F-25
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2002 AND 2003
(IN THOUSANDS, EXCEPT SHARE DATA)
|
2002 |
2003 |
|||||||
---|---|---|---|---|---|---|---|---|---|
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 related party | 250,305 | | |||||||
Current maturities, capital lease obligations | 3,505 | 3,646 | |||||||
Total current liabilities | 280,182 | 18,827 | |||||||
Amended and Restated Cisco Note related party | | 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; 1,055,000 and 19,750,000 shares authorized, respectively; 174,191 and 653,567 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 61,461 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 | |||||
The accompanying notes are an integral part of these consolidated balance sheets.
F-26
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2001, DECEMBER 31, 2002 AND DECEMBER 31, 2003
(IN THOUSANDS EXCEPT SHARE AND PER
SHARE AMOUNTS)
|
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, exclusive of amounts shown separately) | 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 related party | | | 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 |
$ |
(951.82 |
) |
$ |
(616.34 |
) |
$ |
363.47 |
||
Extraordinary gain | | $ | 51.89 | | ||||||
Basic net (loss) income per common share | $ | (951.82 | ) | $ | (564.45 | ) | $ | 363.47 | ||
Beneficial conversion charge | $ | (343.78 | ) | | $ | (134.29 | ) | |||
Basic net (loss) income per common share available to common shareholders | $ | (1,295.60 | ) | $ | (564.45 | ) | $ | 229.18 | ||
Diluted net (loss) income per common share before extraordinary item | $ | (951.82 | ) | $ | (616.34 | ) | $ | 17.73 | ||
Extraordinary gain | | $ | 51.89 | | ||||||
Diluted net (loss) income per common share | $ | (951.82 | ) | $ | (564.45 | ) | $ | 17.73 | ||
Beneficial conversion charge | $ | (343.78 | ) | | $ | (6.55 | ) | |||
Diluted net (loss) income per common share available to common shareholders | $ | (1,295.60 | ) | $ | (564.45 | ) | $ | 11.18 | ||
Weighted-average common shares basic | 70,300 | 162,712 | 387,218 | |||||||
Weighted-average common shares diluted | 70,300 | 162,712 | 7,938,898 |
The accompanying notes are an integral part of these consolidated statements.
F-27
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, DECEMBER 31, 2002 AND DECEMBER 31, 2003
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
|
Common stock |
|
|
|
|
Preferred StockA |
Preferred StockB |
Preferred StockC |
||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Additional Paid-in Capital |
Deferred Compensation |
Treasury Stock |
Stock Purchase Warrants |
||||||||||||||||||||||||||||||
|
Shares |
Amount |
Shares |
Amount |
Shares |
Amount |
Shares |
Amount |
||||||||||||||||||||||||||
Balance, December 31, 2000 | 70,035 | $ | 1 | $ | 189 | $ | | $ | | $ | | 26,000,000 | $ | 25,892 | 19,809,783 | $ | 90,009 | | $ | | ||||||||||||||
Exercises of stock options | 456 | | 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 | 70,491 | 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 | 365 | | 1 | | | | | | | | | | ||||||||||||||||||||||
Issuance of common stock, options and warrants Allied Riser merger | 100,484 | 3 | 10,230 | | | 764 | | | | | | | ||||||||||||||||||||||
Deferred compensation adjustments | | | (1,756 | ) | 1,726 | | | | | | | | | |||||||||||||||||||||
Conversion of Series B convertible preferred stock | 2,853 | | 2,000 | | | | | | (439,560 | ) | (2,000 | ) | | | ||||||||||||||||||||
Foreign currency translation | | | | | | | | | | | | | ||||||||||||||||||||||
Amortization of deferred compensation | | | | 3,331 | | | | | | | | | ||||||||||||||||||||||
Net loss | | | | | | | | | | | | | ||||||||||||||||||||||
Balance at December 31, 2002 | 174,192 | 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 | 538,786 | 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 | (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 | | | | | | | |