Cogent Communications Group Form 10-K
pdfSECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended December 31, 2007 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934. For the transition period from to Commission file number 1-31227 COGENT COMMUNICATIONS GROUP, INC. (Exact Name of Registrant as Specified in Its Charter) Delaware 52-2337274 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 1015 31 st Street N.W. Washington, D.C. 20007 (Address of Principal Executive Offices) (Zip Code) (202) 295-4200 Registrants Telephone Number, Including Area Code Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $0.001 per share Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes No Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non- accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated
filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No The number of shares outstanding of the issuers common stock, par value $0.001 per share, as of February 15, 2008 was 47,912,864. The aggregate market value of the Common Stock held by non-affiliates of the registrant, based on the closing price of $29.87 per share on June 29, 2007 as reported by the NASDAQ Global Select Market was
approximately $1.3 billion. COGENT COMMUNICATIONS GROUP, INC. FORM 10-K ANNUAL REPORT FOR THE YEAR ENDED DECEMBER 31, 2007 TABLE OF CONTENTS Page Part IFinancial Information Item 1 Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Item 1A Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Item 2 Description of Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Item 3 Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Item 4 Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . 18 Part IIOther Information Item 5 Market for the Registrants Common Equity and Related Stockholder Matters . . . . . . 19 Item 6 Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Item 7 Managements Discussion and Analysis of Financial Condition and
Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Item 7A Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . 39 Item 8 Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Item 9A Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Item 9B Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Part III Item 10 Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Item 11 Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Item 12 Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . 70 Item 13 Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Item 14 Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Part IV Item 15 Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrants definitive proxy statement for the registrants 2008 annual shareholders meeting are incorporated by reference in Part III of this Form 10-K. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This report may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are not statements of
historical facts, but rather reflect our current expectations concerning future results and events. You can
identify these forward-looking statements by our use of words such as anticipates, believes,
continues, expects, intends, likely, may, opportunity, plans, potential, project,
will, and similar expressions to identify forward-looking statements, whether in the negative or the
affirmative. We cannot guarantee that we actually will achieve these plans, intentions or expectations.
These forward-looking statements are subject to risks, uncertainties and other factors, some of which
are beyond our control, which could cause actual results to differ materially from those forecasts or
anticipated in such forward-looking statements. You should not place undue reliance on these forward-looking statements, which reflect our view only as of the date of this report. We undertake no obligation to update these statements or publicly
release the result of any revisions to these statements to reflect events or circumstances after the date
of this report or to reflect the occurrence of unanticipated events. 2 PART I ITEM 1. BUSINESS Overview We are a leading facilities-based provider of low-cost, high-speed Internet access and Internet Protocol, or IP, communications services. Our network is specifically designed and optimized to transmit
data using IP. We deliver our services to small and medium-sized businesses, communications service
providers and other bandwidth-intensive organizations through approximately 15,000 customer
connections in North America and Europe. Our primary on-net service is Internet access at a speed of 100 Megabits per second, much faster than typical Internet access currently offered to businesses. We offer this on-net service exclusively
through our own facilities, which run all the way to our customers premises. Because of our integrated
network architecture, we are not dependent on local telephone companies to serve our on-net
customers. Our typical customers in multi-tenant office buildings are law firms, financial services firms,
advertising and marketing firms and other professional services businesses. We also provide on-net
Internet access to certain bandwidth-intensive users such as universities, other ISPs and commercial
content providers at speeds of up to ten Gigabits per second. For the years ended December 31, 2007,
2006 and 2005 our on-net customers generated 79.0%, 70.6% and 57.9%, respectively, of our total net
service revenue. In addition to providing our on-net services, we also provide Internet connectivity to customers that are not located in buildings directly connected to 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. For the years ended December 31, 2007, 2006 and 2005, our off-net
customers generated 17.3%, 23.1%, and 33.0%, respectively, of our total net service revenue. Non-core services are those services we acquired and continue to support but do not actively sell. For the years ended December 31, 2007, 2006 and 2005, non-core services generated 3.7% and 6.3%
and 9.1%, respectively, of our total net service revenue. We also operate 34 data centers comprising approximately 300,000 square feet throughout North America and Europe that allow customers to co-locate their equipment and access our network. Competitive Advantages We believe we address many of the 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 offer a streamlined set of products on an integrated network that operates on a single protocol. Our network design allows us to avoid many of the costs associated with
circuit-switched networks related to provisioning, monitoring and maintaining multiple transport
protocols. We believe that our low cost of operation gives us greater pricing flexibility and an advantage
in a competitive environment characterized by falling Internet access prices. Independent Network. Our on-net 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 customers 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 ten days. High Quality, Reliable Service. We are able to offer high-quality Internet service due to our network, which was designed solely to transmit IP data, and dedicated intra-city bandwidth for each 3 customer. This design increases the speed and throughput of our network and reduces the number of
data packets dropped during transmission. Low Capital Cost to Grow Our Business. We have incurred relatively minimal indebtedness in growing our business because of our network design of using Internet routers without additional legacy
equipment and our strategy of acquiring optical fiber from the excess capacity in existing networks. Experienced Management Team. Our senior management team is composed of seasoned executives with extensive expertise in the telecommunications industry as well as knowledge of the markets in
which we operate. The members of our senior management team have an average of over 20 years of
experience in the telecommunications industry. Our senior management team has designed and built
our network and led the integration of our network assets, customers and service offerings we acquired
through 13 acquisitions. Convergence. There is a clear industry and market trend for legacy products (e.g., TDM voice, Private Line, Frame Relay, and Asynchronous Transfer Mode) to converge on IP. Many of our
competitors will have to migrate their existing customers and products to IP. This migration can be
costly, lengthy, and risky. We do not face this challenge because our network and products are IP. Our Strategy We intend to become the leading provider of high quality Internet access and IP communications services and to continue to improve our profitability and cash flow. The principal elements of our
strategy include: Focus on Providing Low-Cost, High-Speed Internet Access and IP Connectivity. We intend to further load our high-capacity network to respond to the growing demand for high-speed Internet service
generated by bandwidth-intensive applications such as streaming media, online gaming, video, voice
over IP (VOIP), remote data storage, distributed computing and virtual private networks. We intend to
do so by continuing to offer our high-speed and high capacity services at competitive prices. Pursuing On-Net Customer Growth. We intend to increase usage of our network and operational infrastructure by adding customers in our existing on-net buildings, as well as adding buildings to our
network. Selectively Pursuing Acquisition Opportunities. In addition to adding customers through our sales and marketing efforts, we will continue to seek out acquisition opportunities that increase our customer
base, allowing us to take advantage of the unused capacity of our network and add revenues with
minimal incremental costs. We may also make additional acquisitions to add network assets at attractive
prices. Our Network Our network is comprised of in-building riser facilities, metropolitan optical networks, metropolitan traffic aggregation points and inter-city transport facilities. We believe that we deliver a high level of
technical performance because our network is optimized for IP traffic. We believe that our network is
more reliable and delivers IP traffic at lower cost than networks built as overlays to traditional circuit-
switched telephone networks. Our network serves 100 metropolitan markets in North America and Europe and encompasses: over 900 multi-tenant office buildings strategically located in commercial business districts; over 300 carrier-neutral Internet aggregation facilities, data centers and single-tenant buildings; over 250 intra-city networks consisting of over 10,400 fiber miles; 4 an inter-city network of more than 26,900 fiber route miles; and multiple leased high-capacity transatlantic circuits connecting the North American and European portions of our network. We have created our network by acquiring optical fiber from carriers with large amounts of unused fiber and directly connecting Internet routers to our existing optical fiber national backbone. We have
expanded our network through key acquisitions of financially distressed companies or their assets at a
significant discount to their original cost. Due to our network design and acquisition strategy, we
believe we are positioned to grow our revenue and increase profitability with limited incremental
capital expenditures. We expect our 2008 capital expenditure rate to be similar to the rate we
experienced in 2007. Inter-city Networks Our inter-city network consists of optical fiber connecting major cities in North America and Europe. The North American and European portions of our network are connected by transatlantic
circuits. Our network was built by acquiring from various owners of fiber optic networks the right to
use one or two strands of optical fiber out of the multiple fibers owned by the carrier. We have
installed the optical and electronic equipment necessary to amplify, regenerate, and route the optical
signals along these networks. We have the right to use the fiber under long term agreements. We pay
these providers fees for the maintenance of the optical fiber and provide our own equipment
maintenance. The larger providers of our inter-city optical fiber are WilTel (now part of Level 3) in the
United States, LDCOM (now part of Neuf Cegetel in France, MTI in Germany, Telia Sonera in
Europe, and RENFE (adif) in Spain. Intra-city Networks In each metropolitan area in which we provide high-speed on-net Internet access service, our backbone network is connected to a router connected to one or more of our metropolitan optical
networks. We create our intra-city networks by obtaining the right to use optical fiber from carriers
with large amounts of dark fiber. These metropolitan networks consist of optical fiber that runs from
the central router in a market into routers located in our on-net buildings. In most cases 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. Within the cities where we offer off-net Internet access service, we lease circuits from telecommunications carriers, primarily local telephone companies, to provide the last mile connection
to the customers 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-Building Networks In office buildings where we provide service to multiple tenants we connect our routers to a cable containing 12 to 288 optical fiber strands that typically run from our equipment in 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 customers 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.
We believe that Ethernet is the lowest cost network connection technology and is used almost
universally for the local area networks that businesses operate. 5 Internetworking The Internet is an aggregation of interconnected networks. We interconnect our network with most major and hundreds of minor Internet Service Providers, or ISPs, at approximately 70 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
customers traffic, such as email, to reach and be received from customers of other ISPs. We are
considered a Tier 1 ISP and, as a result, we have settlement-free peering arrangements with most other
providers. This allows us to exchange traffic with those ISPs without payment by either party. In such
arrangements, each party exchanging traffic bears its own cost of delivering traffic to the point at which
it is handed off to the other party. We also engage in public peering arrangements in which each party
also pays a fee to the owner of routing equipment that operates as the central exchange for all the
participants. We do not treat our settlement-free peering arrangements as generating revenue or
expense related to the traffic exchanged. Where we do not have settlement-free peering connection
with an ISP, we exchange traffic through an intermediary, whereby such intermediary receives payment
from us. Currently, less than 1% of our traffic is handled this way. Network Management and Control Our primary network operations centers are located in Washington, D.C and Madrid, Spain. These facilities provide continuous operational support in both North America and Europe. Our network
operations centers are designed to immediately respond to any problems in our network. To ensure the
quick replacement of faulty equipment in the intra-city and long-haul networks, we have deployed field
engineers across North America and Europe. In addition, we have maintenance contracts with 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 10 Gigabit Ethernet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000 Colocation with Internet Access . . . . . . . . . . . . . . . . . . . . . . . . . . 2 to 10,000 Point-to-Point . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5 to 10,000 Off-Net Services T1 or E1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5 or 2.0 T3 or E3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 or 34 Ethernet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10, 100 or 1,000 6 We offer on-net services in 100 metropolitan markets. We serve over 1,200 buildings of which more than 1,050 are located in North America with the remainder located in Europe. Our most popular
on-net service in North America is our Fast Ethernet service, which provides Internet access at 100
megabits per second. We typically offer our Fast Ethernet (Internet access) service to our small and
medium-sized business customers at $1,000 a month for month-to-month service. We offer lower prices
for longer term commitmentstypically $900 per month for a one year term and $800 per month for a
two year term. We also offer Internet access services at higher speeds of up to ten Gigabits per second.
These services are generally used by customers that have businesses, such as web hosting, that are
Internet based and are generally delivered at data centers and carrier hotels. We believe that, on a
per-Megabit basis, this service offering is one of the lowest priced in the marketplace. We also offer
colocation services in 34 locations in North America and Europe. This service offers Internet access
combined with rack space and power in a Cogent facility, allowing the customer to locate a server or
other equipment at that location and connect to our Internet service. Our final on-net service offering
is our Point-to-Point or Layer 2 service. These point-to-point connections span North America and
Europe and allow customers to connect geographically dispersed local area networks in a seamless
manner. We emphasize the sale of on-net services because we believe that we have a competitive
advantage in providing these services and our 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 the metropolitan markets in North America and Europe in which we offer on-net services
and in approximately 5 additional markets. These services are generally provided to small and medium-
sized businesses in approximately 2,700 off-net buildings. A significant amount of our off-net revenues
were acquired revenues, which have historically churned at a greater rate than our on-net revenues. We
expect the revenue from these off-net services to grow at a slower rate than our on-net revenues. We support certain non-core services assumed with certain of our acquisitions. These services include our managed modem service, voice services in Toronto, Canada, and legacy point-to-point
services. Our managed modem service is offered to larger businesses and other Internet service
providers that serve individuals that dial in to the Internet. The business or ISP is our customer for this
service. Individuals make use of the dial-in access through arrangements with the business or ISP. We
expect the revenue from these non-core services to decline. We do not actively sell these services and
expect the growth of our on-net Internet services to compensate for this loss. Sales and Marketing Sales. We employ a direct sales and marketing approach. As of February 1, 2008, our sales force included 204 full-time employees. Our outside direct sales personnel work through direct face-to-face
contact with potential customers in, or intending to locate in, on-net buildings. Through agreements
with building owners, we are able to initiate and maintain personal contact with our customers by
staging various promotional and social events in our on-net buildings. Direct sales personnel are
compensated with a base salary plus quota-based commissions and incentives. We use a customer
relationship management system to efficiently track activity levels and sales productivity. Agent Program. We also have an agent program used as an alternate channel to distribute our products and services. The agent program consists of value-added resellers, IT consultants, and smaller
telecom agents, who are managed by our direct sales personnel, and larger national or regional
companies whose primary business is to sell telecommunications, data, and Internet services. The agent
program includes over 110 agents. Marketing. Because of our focus on a direct sales force, we have 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 7 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 is responsible for our product strategy
and direction based upon primary and secondary market research and the advancement of new
technologies. Competition We face competition from incumbent carriers, Internet service providers and facilities-based network operators, many of whom are much larger than us, have significantly greater financial
resources, 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 titleholders. We rely on
the maintenance of such dark fiber to provide our on-net services to customers. We are also dependent
on third-party providers, some of whom are our competitors, for the provision of connections 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
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 are usually priced lower than our offerings and thus provide
competitive pressure on pricing, particularly for more price-sensitive customers. 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. 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, 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. In the United States, we are subject to the obligations set forth in the Communications Assistance for Law Enforcement Act, which is administered by the FCC. That law requires that we be able to
intercept communications when required to do so by law enforcement agencies. We are required to
comply or we may face significant fines and penalties. 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 propertys commercial tenants. 8 Our subsidiary, Cogent 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 regulations to the extent they change and to the
extent we begin using facilities in a manner that subjects us to these restrictions. Our European subsidiaries operate in a more highly regulated environment for the types of services they provide. In many European countries, a national license or a notice filed with a regulatory
authority is required for the provision of data and Internet services. In addition, our subsidiaries
operating in member countries of the European Union are subject to the directives and jurisdiction of
the 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. Employees As of February 1, 2008, we had 431 employees. A union represents twenty-two of our employees in France. We believe that we have a satisfactory relationship with our employees. Available Information We make available free of charge through our Internet website our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and any amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. The reports are
made available through a link to the SECs Internet website at www.sec.gov. You can find these reports
and request a copy of our Code of Conduct on our website at www.cogentco.com under the Investor
Relations link. ITEM 1A. RISK FACTORS If our operations do not consistently produce positive cash flow to pay for our growth or meet our operating
and financing obligations, and we are unable to otherwise raise additional capital to meet these needs, our
ability to implement our business plan will be materially and adversely affected. We currently generate positive cash flow from our operations. If we acquire or invest in additional businesses, assets, services or technologies we may need to raise additional capital beyond that available
from our cash flow. We may also face unforeseen capital requirements for new technology required to
remain competitive or to comply with new regulatory requirements, for unforeseen maintenance of our
network and facilities, and for other unanticipated expenses associated with running our business. In
addition, if we do not retain existing customers or add new customers, our cash flow may be impaired
and we may be required to raise additional funds through the issuance of debt or equity. We cannot
assure you that we will have access to necessary capital, nor can we assure you that any such financing
will be available on terms that are acceptable to our stockholders or us. If issuing equity securities
raises additional funds, substantial dilution to existing stockholders may result. 9 We need to retain existing customers and continue to add new customers in order to become profitable and
remain cash flow positive. In order to become profitable and remain consistently cash flow positive, we need to both retain existing customers and continue to add a large number of new customers. The precise number of
additional customers required to become profitable and remain consistently cash flow positive is
dependent on a number of factors, including the turnover of existing customers and the revenue mix
among customers. We may not succeed in adding customers if our sales and marketing plan is
unsuccessful. In addition, many of our target customers are existing businesses that are already
purchasing Internet access services from one or more providers, often under a contractual commitment,
and it has been our experience that such target customers are often reluctant to switch providers due to
costs associated with switching providers. Further, as some of our customers grow larger they may
decide to build their own Internet networks. While no single customer accounted for more than 2.7%
of our 2007 revenues, a migration of a few very large Internet users to their own networks could impair
our growth. We are experiencing rapid growth of our business and operations and we may not be able to efficiently
manage our growth. We have rapidly grown our company through acquisitions of companies, assets and customers as well as implementation of our own network expansion and the acquisition of new customers through
our own sales efforts. Our expansion places significant strains on our management, operational and
financial infrastructure. Our ability to manage our growth will be particularly dependent upon our
ability to: expand, develop and retain an effective sales force and qualified personnel; maintain the quality of our operations and our service offerings; maintain and enhance our system of internal controls to ensure timely and accurate compliance with our regulatory reporting requirements; and expand our accounting and operational information systems in order to support our growth. If we fail to implement these measures successfully, our ability to manage our growth will be impaired. We may experience difficulties in implementing our expansion in Eastern Europe and may incur related
unexpected costs and regulatory issues. In 2007, we began to expand our network into Eastern Europe. We may have difficulty in acquiring dark fiber and other difficulties in making our network operational in this region. The
expansion may cost more that we have planned. We also may experience regulatory issues. Finally, we
may be unsuccessful in selling our services in this region. If we are not successful in developing our
market presence in Eastern Europe our operating results could be adversely impacted. We may experience delays and additional costs in expanding our on-net buildings. Currently, we plan to increase our carrier-neutral facilities and other on-net buildings by approximately 100 buildings in 2008 from 1,217 at December 31, 2007. We may be unsuccessful at
identifying appropriate buildings or negotiating favorable terms for acquiring access to such buildings,
and consequently, may experience difficulty in adding customers to our network and fully using the
networks capacity. 10 We may not successfully make or integrate acquisitions or enter into strategic alliances. As part of our growth strategy, we intend to pursue selected acquisitions and strategic alliances. To date, we have completed 13 acquisitions. We compete with other companies for acquisition
opportunities and we cannot assure you that we will be able to effect future acquisitions or strategic
alliances on commercially reasonable terms or at all. Even if we enter into these transactions, we may
experience: delays in realizing or a failure to realize the benefits we anticipate; difficulties or higher-than-anticipated costs associated with integrating any acquired companies, products or services into our existing business; attrition of key personnel from acquired businesses; unexpected costs or charges; or unforeseen operating difficulties that require significant financial and managerial resources that would otherwise be available for the ongoing development or expansion of our existing
operations. In the past, our acquisitions have often included assets, service offerings and financial obligations that are not compatible with our core business strategy. We have expended management attention and
other resources to the divestiture of assets, modification of products and systems as well as
restructuring financial obligations of acquired operations. In most acquisitions, we have been successful
in renegotiating long-term agreements that we have acquired relating to long distance and local
transport of data and IP traffic. If we are unable to satisfactorily renegotiate such agreements in the
future or with respect to future acquisitions, we may be exposed to large claims for payment for
services and facilities we do not need. Consummating these transactions could also result in the incurrence of additional debt and related interest expense, as well as unforeseen contingent liabilities, all of which could have a material adverse
effect on our business, financial condition and results of operations. Because we have purchased
financially distressed companies or their assets, and may continue to do so in the future, we have not
had, and may not have, the opportunity to perform extensive due diligence or obtain contractual
protections and indemnifications that are customarily provided in corporate acquisitions. As a result, we
may face unexpected contingent liabilities arising from these acquisitions. We may also issue additional
equity in connection with these transactions, which would dilute our existing shareholders. Revenues generated by the customer contracts that we have acquired have accounted for a substantial portion of our historical growth in non-core and off-net service revenues. However,
following an acquisition, we have experienced a decline in revenue attributable to acquired customers
as these customers contracts have expired and they have entered into standard Cogent customer
contracts at generally lower rates or have chosen not to renew service with us. We anticipate that we
will experience similar declines with respect to customers we have acquired or will acquire. We depend upon our key employees and may be unable to attract or retain sufficient qualified personnel. Our future performance depends upon the continued contribution of our executive management team and other key employees, in particular, our Chairman and Chief Executive Officer, Dave
Schaeffer. As founder of our company, Mr. Schaeffers knowledge of our business and our industry
combined with his deep involvement in every aspect of our operations and planning make him
particularly well-suited to lead our company and difficult to replace. 11 Our connections to the Internet require us to establish and maintain relationships with other providers, which
we may not be able to maintain. The Internet is composed of various public and private network providers who operate their own networks and interconnect them at public and private interconnection points. Our network is one such
network. In order to obtain Internet connectivity for our network, we must establish and maintain
relationships with other providers and incur the necessary capital costs to locate our equipment and
connect our network at these various interconnection points. By entering into what are known as settlement-free peering arrangements, providers agree to exchange traffic between their respective networks without charging each other. Our ability to avoid the
higher costs of acquiring dedicated network capacity and to maintain high network performance is
dependent upon our ability to establish and maintain peering relationships. The terms and conditions
of our peering relationships may also be subject to adverse changes, which we may not be able to
control. For example, several network operators with large numbers of individual users are arguing that
they should be able to charge or charge more to network operators and businesses that send traffic to
those users. If we are not able to maintain or increase our peering relationships in all of our markets
on favorable terms, we may not be able to provide our customers with high performance or affordable
services, which could have a material adverse effect on our business. We have in the past encountered
some disputes with certain of our providers regarding our peering arrangements, but we have generally
been able to route our traffic through alternative peering arrangements, resolve such disputes, or
terminate such peering arrangements with a minimal adverse impact on our business. In the past we
had two such disputes that resulted in a temporary disruption of the exchange of traffic between our
network and the network of the other carrier. We continue to experience resistance from certain
incumbent telephone companies, especially in Europe, to the upgrade of settlement free peering
connections necessary to accommodate the growth of traffic we send to such carriers. We cannot assure
you that we will be able to continue to establish and maintain relationships with providers or favorably
resolve disputes with providers. We make some of our connections to other Internet networks pursuant to agreements through carriers 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 costs may rise. Our business could suffer because telephone companies and cable companies may provide better delivery of
Internet content originating on their own networks. Broadband connections provided by cable TV and telephone companies have become the predominant means by which consumers connect to the Internet. The providers of these broadband
connections may treat Internet content delivered from different sources differently. The possibility of
this has been characterized as an issue of net neutrality. As many of our customers operate websites
and services that deliver content to consumers our ability to sell our services would be negatively
impacted if Internet content delivered by us was less easily received by consumers than Internet content
delivered by others. We have substantial debt which we may not be able to repay when due. We have $200.0 million of senior convertible notes outstanding. The holders of the notes have the right to compel us to repurchase for cash on June 15, 2014, June 15, 2017 and June 15, 2022, all or
some of their notes. They also have the right to be paid the principal upon default and upon certain
designated events, such as certain changes of control. We may not have sufficient funds to pay the
principal at the time we are obligated to do so, which could result in bankruptcy, or we may only be
able to raise the funds on unfavorable terms. 12 The holders of our senior convertible notes have the right to convert their notes to common stock. The holders of our senior convertible notes are under certain circumstances able to convert their notes into common stock at a conversion price of $49.18 per share of common stock and to obtain
additional shares of common stock. If our share price exceeds $49.18 and the conversion right is
exercised by the holders of the notes the number of our shares of common stock outstanding will
increase which could reduce further appreciation in our stock price and impact our per share earnings.
Rather than issue the stock we are permitted to pay the cash equivalent in value to the stock to be
issued. We might not have sufficient funds to do this or doing so might have other detrimental impacts
on us. Our operations outside of the United States expose us to economic, regulatory and other risks. The nature of our European and Canadian business involves a number of risks, including: fluctuations in currency exchange rates; exposure to additional regulatory and legal requirements, including import restrictions and controls, exchange controls, tariffs and other trade barriers; difficulties in staffing and managing our foreign operations; changes in political and economic conditions; and exposure to additional and potentially adverse tax regimes. As we continue to expand our European and Canadian businesses, our success will depend, in part, on our ability to anticipate and effectively manage these and other risks. Our failure to manage
these risks and grow our European and Canadian operations may have a material adverse effect on our
business and results of operations. Fluctuations in foreign exchange rates may adversely affect our financial position and results of operations. Our European and Canadian operations expose us to currency fluctuations and exchange rate risk. For example, while we record revenues and financial results from our European operations in euros,
these results are reflected in our consolidated financial statements in U.S. dollars. Therefore, our
reported results are exposed to fluctuations in the exchange rates between the U.S. dollar and the euro.
We fund our euro-based operating expenses and associated cash flow requirements of our European
operations, including IRU obligations, in U.S. dollars. Accordingly, in the event that the euro
strengthens versus the dollar to a greater extent than we anticipate, the expenses and cash flow
requirements associated with our European operations may be significantly higher in U.S.-dollar terms
than planned. Our business could suffer delays and problems due to the actions of network providers on whom we are
partially dependent. Our off-net customers are connected to our network by means of communications lines that are provided as services by local telephone companies and others. We may experience problems with the
installation, maintenance and pricing of these lines and other communications links, which could
adversely affect our results of operations and our plans to add additional customers to our network
using such services. We have historically experienced installation and maintenance delays when the
network provider is devoting resources to other services, such as traditional telephony. We have also
experienced pricing problems when a lack of alternatives allows a provider to charge high prices for
services in an area. We attempt to reduce this problem by using many different providers so that we
have alternatives for linking a customer to our network. Competition among the providers tends to
improve installation, maintenance and pricing. 13 Our network could suffer serious disruption if certain locations experience serious damage. There are certain locations through which a large amount of our Internet traffic passes. Examples are facilities in which we exchange traffic with other carriers, the facility through which our
transatlantic traffic passes, and certain of our network hub sites. If any of these facilities were
destroyed or seriously damaged a significant amount of our network traffic could be disrupted. Because
of the large volume of traffic passing through these facilities our ability (and the ability of carriers with
whom we exchange traffic) to quickly restore service would be challenged. There could be parts of our
network or the networks of other carriers that could not be quickly restored or that would experience
substantially reduced service for a significant time. If such a disruption occurs, our reputation could be
negatively impacted which may cause us to lose customers and adversely affect our ability to attract
new customers and our operating results. If the information systems that we depend on to support our customers, network operations, sales, billing and
financial reporting 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, bill our
customers for those services and prepare our financial statements depends upon the effective
integration of our various information systems. If our systems, individually or collectively, fail or do not
perform as expected, our ability to process and provision orders, to make timely payments to vendors,
to ensure that we collect revenue owed to us and prepare our financial statements would be adversely
affected. Such failures or delays could result in increased capital expenditures, customer and vendor
dissatisfaction, loss of business or the inability to add new customers or additional services, and prepare
accurate and timely financial statements all of which would adversely affect our business and results of
operations. We have historically incurred operating losses and these losses may continue for the foreseeable future. Since we initiated operations in 2000, we have generated operating losses and these losses may continue for the foreseeable future. In 2005 we had an operating loss of $62.1 million, in 2006 we had
an operating loss of $46.6 million and in 2007 we had an operating loss of $29.9 million. As of
December 31, 2007, we had an accumulated deficit of $296.0 million. Continued losses may prevent us
from pursuing our strategies for growth or may require us to seek unplanned additional capital and
could cause us to be unable to meet our debt service obligations, capital expenditure requirements or
working capital needs. We may have difficulty intercepting communications as required by the U.S. Communications Assistance for
Law Enforcement Act. The U.S. Communications Assistance for Law Enforcement Act requires that we be able to intercept communications when required to do so by law enforcement agencies. We may experience
difficulties and incur significant costs in complying with the law. If we are unable to comply with the
laws we could be subject to fines of up to $1.0 million per event and other penalties. Our business could suffer from an interruption of service from our fiber providers. The carriers from whom we have obtained our inter-city and intra-city dark fiber maintain that fiber. If these carriers fail to maintain the fiber or disrupt our fiber connections for other reasons, such
as business disputes with us and governmental takings, our ability to provide service in the affected
markets or parts of markets would be impaired. The companies that maintain our inter-city dark fiber
and many of the companies that maintain our intra-city dark fiber are also competitors of ours. 14 Consequently, they may have incentives to act in ways unfavorable to us. While we have successfully
mitigated the effects of prior service interruptions and business disputes in the past, we may incur
significant delays and costs in restoring service to our customers in connection with future service
interruptions, and we may lose customers if delays are substantial. Our business depends on agreements with colocation operators, which we could fail to obtain or maintain. Our business depends upon access to customers in carrier neutral colocation centers, which are facilities in which many large users of the Internet house the computer servers that deliver content and
applications to users by means of the Internet and provide access to multiple Internet access networks.
Most colocation centers allow any carrier to operate within the facility (for a standard fee). We expect
to enter into additional colocation agreements as part of our growth plan. Current government
regulations do not require colocation operators to allow all carriers access on terms that are reasonable
or nondiscriminatory. We have been successful in obtaining agreements with these operators in the past
and have generally found that the operators want to have us in their colocation facilities because we
offer low-cost, high capacity Internet service to their other customers. Any deterioration in our existing
relationships with these colocation center operators could harm our sales and marketing efforts and
could substantially reduce our potential customer base. Our business depends on license agreements with building owners and managers, which we could fail to
obtain or maintain. Our on-net 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 these buildings. These agreements typically have terms of five to ten years, with
one or more renewal options. Any deterioration in our existing relationships with building owners or
managers could harm our sales and marketing efforts and could substantially reduce our potential
customer base. We expect to enter into additional access agreements as part of our growth plan.
Current federal and state regulations do not require building owners to make space available to us or
to do so on terms that are reasonable or nondiscriminatory. While the FCC has adopted regulations
that prohibit common carriers under its jurisdiction from entering into exclusive arrangements with
owners of multi-tenant commercial office buildings, these regulations do not require building owners to
offer us access to their buildings. Building owners or managers may decide not to permit us to install
our networks in their buildings or may elect not to renew or amend our access agreements. The initial
term of most of our access agreements will conclude in the next several years. Most of these
agreements have one or more automatic renewal periods and others may be renewed at the option of
the landlord. While we have historically been successful in renewing these agreements and no single
building access agreement is material to our success, the failure to obtain or maintain a number of
these agreements would reduce our revenue, and we might not recover our costs of procuring building
access and installing our in-building networks. We may not be able to obtain or construct additional building laterals to connect new buildings to our
network. In order to connect a new building to our network we need to obtain or construct a lateral from our metropolitan network to the building. We may not be able to obtain fiber in an existing lateral at
an attractive price from a provider and may not be able to construct our own lateral due to the cost of
construction or municipal regulatory restrictions. Failure to obtain fiber in an existing lateral or to
construct a new lateral could keep us from adding new buildings to our network and from increasing
our revenues. 15 Impairment of our intellectual property rights and our alleged infringement on other companies intellectual
property rights could harm our business. We are aware of several other companies in our and other industries that use the word Cogent in their corporate names. One company has informed us that it believes our use of the name Cogent
infringes on their intellectual property rights in that name. If such a challenge is successful, we could be
required to change our name and lose the goodwill associated with the Cogent name in our markets. The sector in which we operate is highly competitive, and we may not be able to compete effectively. We face significant competition from incumbent carriers, Internet service providers and facilities- based network operators. Relative to us, many of these providers have significantly greater financial
resources, more well-established brand names, larger customer bases, and more diverse strategic plans
and service offerings. Intense competition from these traditional and new communications companies has led to declining prices and margins for many communications services, and we expect this trend to continue as
competition intensifies in the future. Decreasing prices for high-speed Internet services have somewhat
diminished the competitive advantage that we have enjoyed as a result of our service pricing. Our competitors may also introduce new technology or services that make our services less attractive to potential customers. For example, some providers are introducing a new version of the
Internet protocol (Ipv6) that we do not plan to introduce at this time. If this becomes important to
Internet users our ability to compete may be lessened or we may have to incur additional costs in order
to accommodate this technology. We issue projected results and estimates for future periods from time to time, and such projections and
estimates are subject to inherent uncertainties and may prove to be inaccurate. Financial information, results of operations and other projections that we may issue from time to time are based upon our assumptions and estimates. While we believe these assumptions and estimates
to be reasonable when they are developed, they are inherently subject to significant business, economic
and competitive uncertainties and contingencies, many of which are beyond our control. You should
understand that certain unpredictable factors could cause our actual results to differ from our
expectations and those differences may be material. No independent expert participates in the
preparation of these estimates. These estimates should not be regarded as a representation by us as to
our results of operations during such periods as there can be no assurance that any of these estimates
will be realized. In light of the foregoing, we caution you not to place undue reliance on these
estimates. These estimates constitute forward-looking statements. Network failure or delays and errors in transmissions expose us to potential liability. Our network uses a collection of communications equipment, software, operating protocols and proprietary applications for the high-speed transportation of large quantities of data among multiple
locations. Given the complexity of our network, it is possible that data will be lost or distorted. Delays
in data delivery may cause significant losses to one or more customers using our network. Our network
may also contain undetected design faults and software bugs that, despite our testing, may not be
discovered in time to prevent harm to our network or to the data transmitted over it. The failure of
any equipment or facility on the network could result in the interruption of customer service until we
effect necessary repairs or install replacement equipment. Network failures, delays and errors could also
result from natural disasters, power losses, security breaches, computer viruses, denial of service attacks
and other natural or man-made events. Our off-net services are dependent on the networks of other
providers or on local telephone companies. Network failures, faults or errors could cause delays or 16 service interruptions, expose us to customer liability or require expensive modifications that could have
a material adverse effect on our business. As an Internet access provider, we may incur liability for information disseminated through our network. The law relating to the liability of Internet access providers and on-line services companies for information carried on or disseminated through their networks is unsettled. As the law in this area
develops and as we expand our international operations, the potential imposition of liability upon us
for information carried on and disseminated through our network could require us to implement
measures to reduce our exposure to such liability, which may require the expenditure of substantial
resources or the discontinuation of certain products or service offerings. Any costs that are incurred as
a result of such measures or the imposition of liability could harm our business. Legislation and government regulation could adversely affect us. As an enhanced service provider, we are not subject to substantial regulation by the FCC or the state public utilities commissions in the United States. Internet service is also subject to minimal
regulation in Europe and in Canada. If we decide to offer traditional voice services or otherwise
expand our service offerings to include services that would cause us to be deemed a common carrier,
we will become subject to additional regulation. Additionally, if we offer voice service using IP (voice
over IP) or offer certain other types of data services using IP we may become subject to additional
regulation. This regulation could impact our business because of the costs and time required to obtain
necessary authorizations, the additional taxes than we may become subject to or may have to collect
from our customers, and the additional administrative costs of providing voice services, and other costs.
Even if we do not decide to offer additional services, governmental authorities may decide to impose
additional regulation and taxes upon providers of Internet service. All of these could inhibit our ability
to remain a low cost carrier. Much of the law related to the liability of Internet service providers remains unsettled. For example, many jurisdictions have adopted laws related to unsolicited commercial email or spam in
the last several years. Other legal issues, such as the sharing of copyrighted information, transborder
data flow, universal service, and liability for software viruses could become subjects of additional
legislation and legal development. We cannot predict the impact of these changes on us. Regulatory
changes could have a material adverse effect on our business, financial condition or results of
operations. Terrorist activity throughout the world and military action to counter terrorism could adversely impact our
business. The September 11, 2001 terrorist attacks in the United States and the continued threat of terrorist activity and other acts of war or hostility have had, and may continue to have, an adverse effect on
business, financial and general economic conditions internationally. Effects from these events and any
future terrorist activity, including cyber terrorism, may, in turn, increase our costs due to the need to
provide enhanced security, which would adversely affect our business and results of operations. These
circumstances may also damage or destroy the Internet infrastructure and may adversely affect our
ability to attract and retain customers, our ability to raise capital and the operation and maintenance of
our network access points. We are particularly vulnerable to acts of terrorism because our largest
customer concentration is located in New York, our headquarters is in Washington, D.C., and we have
significant operations in Paris and Madrid, cities that have historically been targets for terrorist attacks. ITEM 2. DESCRIPTION OF PROPERTIES We lease and own space for offices, data centers, colocation facilities, and points-of-presence. 17 Our headquarters facility consists of approximately 15,370 square feet located in Washington, D.C. The lease for our headquarters is with an entity controlled by our Chief Executive Officer. The lease
expires on August 31, 2010. We also lease a total of approximately 414,000 square feet of space in 63 locations to house our colocation facilities, corporate headquarters, regional offices and operations centers. The remaining
term of these leases ranges from 6 months to 8 years with, in many cases, options to renew. We believe that these facilities are generally in good condition and suitable for our operations. ITEM 3. LEGAL PROCEEDINGS We are involved in 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. For a
discussion of the significant proceedings in which we are involved, see Note 7 to our consolidated
financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of our security holders during the quarter ended December 31, 2007. 18 PART II ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS Our sole class of common equity is our common stock, par value $0.001, which is currently traded on the NASDAQ Global Select Market under the symbol CCOI. Prior to March 6, 2006, our
common stock 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. As of February 1, 2008, there were approximately 155 holders of record of shares of our common stock holding 48,025,164.shares of our common stock. The table below shows, for the quarters indicated, the reported high and low trading prices of our common stock. High Low Calendar Year 2006
First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9.77 $ 5.13 Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.41 7.79 Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.77 7.78 Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17.00 11.14 Calendar Year 2007
First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $24.91 $15.74 Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30.09 22.07 Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34.90 20.08 Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30.16 19.67 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. 19 8FEB200812150586 Performance Graph The Company, in connection with its merger with Allied Riser Communications Corporation, began trading shares of its common stock on the American Stock Exchange in February 2002. On
March 6, 2006, the Companys shares of Common Stock began trading on the NASDAQ National
Market. The Companys common stock currently trades on the NASDAQ Global Select Market. The
chart below compares the relative changes in the cumulative total return of the Companys Common
Stock for the period December 31, 2002December 31, 2007, against the cumulative total return for
the same period of the (1) The Standard & Poors 500 (S&P 500) Index and (2) an industry peer group
consisting of Savvis Communications Corporation (NASDAQ: SVVS); Internap Network Services
Corporation (NASDAQ: INAP); and Time Warner Telecom Inc. (NASDAQ: TWTC). The comparison
assumes $100 was invested on December 31, 2002 in the Companys common stock, the S&P 500 Index
and the industry peer group, with dividends, if any, reinvested. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* AMONG COGENT COMMUNICATIONS GROUP, INC. THE S&P 500 INDEX AND A PEER GROUP 12/02 12/03 12/04 12/05 12/07 12/06 $0 $100 $200 $300 $400 $500 $600 $700 Cogent Communications Group Peer Group (1) S&P 500 Value of $100 Invested on December 31, 2002. 12/02 12/03 12/04 12/05 12/06 12/07 Cogent Communications Group . . . . . . . . 100.00 307.89 284.21 72.24 213.42 311.97 S&P 500 . . . . . . . . . . . . . . . . . . . . . . . . . 100.00 128.68 142.69 149.70 173.34 182.87 Peer Group(1) . . . . . . . . . . . . . . . . . . . . . 100.00 513.27 226.31 235.85 639.14 548.98 * $100 invested on 12/31/02 in stock or index-including reinvestment of dividends.
Fiscal year ending December 31. Copyright 2008, Standard & Poors, a division of The McGraw-Hill Companies, Inc. All rights reserved. www.researchdatagroup.com/S&P.htm 20 Unregistered Sales of Equity Securities and Use of Proceeds. On August 14, 2007, the Company announced that on August 14, 2007 its Board of Directors had authorized a plan to permit the repurchase of up to $50.0 million of shares of the Companys common
stock in negotiated and open market transactions through December 31, 2008. As of December 31,
2007, the Company had purchased 445,990 shares of its common stock pursuant to this authorization
for an aggregate of $9.9 million; approximately $40.1 million remained available for such negotiated
and open market transactions concerning the Companys common stock. The Company may purchase
shares from time to time depending on market, economic, and other factors. The authorization will
continue unless withdrawn by the Board of Directors. The following table summarizes the Companys common stock repurchases during the fourth quarter of 2007 made pursuant to this authorization. During the quarter, the Company did not
purchase shares outside of this program, and all purchases were made by or on behalf of the Company
and not by any affiliated purchaser (as defined by Rule 10b-18 of the Securities Exchange Act of
1934). Issuer Purchases of Equity Securities Total Total Number of Shares Maximum Number (or Number of Average (or Units) Purchased as Approximate Dollar Value) of Shares Price Paid Part of Publicly Shares (or Units) that (or Units) per Share Announced Plans May Yet Be Purchased Under Period Purchased (or (Unit) or Programs the Plans or Programs October 1 - 31, 2007 . . . . . . . . . 0 0 193,989 $45,563,602 November 1 - 30, 2007 . . . . . . . . 217,001 $21.93 410,990 $40,805,206 December 1 - 31, 2007 . . . . . . . . 35,000 $20.07 445,990 $40,102,717 21 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The annual financial information set forth below has been derived from our audited consolidated financial statements. The information should be read in connection with, and is qualified in its entirety
by reference to, Managements Discussion and Analysis, the consolidated financial statements and notes
included elsewhere in this report and in our SEC filings. Years Ended December 31, 2003 2004 2005 2006 2007 (dollars in thousands) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Service revenue, net . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 59,422 $ 91,286 $ 135,213 $ 149,071 $ 185,663 Operating expenses:
Network operations . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,017 63,466 85,794 80,106 87,548 Equity-based compensation expensenetwork operations . . 1,307 858 399 315 208 Selling, general, and administrativeSG&A . . . . . . . . . . . 26,570 40,382 41,344 46,593 52,011 Equity-based compensation expenseSG&A . . . . . . . . . . 17,368 11,404 12,906 10,194 10,176 Terminated public offering costs . . . . . . . . . . . . . . . . . . . 779 Lease restructuring charges . . . . . . . . . . . . . . . . . . . . . . 1,821 1,319 Depreciation and amortization . . . . . . . . . . . . . . . . . . . . 48,387 56,645 55,600 58,414 65,638 Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . 140,649 175,355 197,362 195,622 215,581 Operating loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (81,227) (84,069) (62,149) (46,551) (29,918) Gainslease obligation restructurings . . . . . . . . . . . . . . . 5,292 844 255 2,110 GainAllied Riser note exchange . . . . . . . . . . . . . . . . . 24,802 GainsCisco credit facility . . . . . . . . . . . . . . . . . . . . . . 215,432 842 Gainsdispositions of assets . . . . . . . . . . . . . . . . . . . . . 3,372 254 95 Interest income (expense) and other, net . . . . . . . . . . . . . (18,264) (10,883) (10,427) (7,715) (3,312) Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,743 (89,660) (67,518) (53,757) (31,025) Beneficial conversion charges . . . . . . . . . . . . . . . . . . . . (52,000) (43,986) Net income (loss) applicable to common shareholders . . . . $ 88,743 $(133,646) $ (67,518) $ (53,757) $ (31,025) Net income (loss) per common share available to common shareholdersbasic and diluted . . . . . . . . . . . . . . . . . $ 11.18 $ (175.03) $ (1.96) $ (1.16) $ (0.65) Weighted-average common sharesbasic . . . . . . . . . . . . . 7,935,831 763,540 34,439,937 46,343,372 47,800,159 Weighted-average common sharesdiluted . . . . . . . . . . . 7,938,838 763,540 34,439,937 46,343,372 47,800,159 CONSOLIDATED BALANCE SHEET DATA (AT PERIOD END): Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . $ 7,875 $ 13,844 $ 29,883 $ 42,642 $ 177,021 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344,440 378,586 351,373 336,876 455,325 Long-term debt (including capital leases and current portion) (net of unamortized discount of $5,026 in 2004,
$3,478 in 2005, $1,213 in 2006 and $4,133 in 2007) . . . . . 83,702 126,382 99,105 97,024 288,441 Preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97,681 139,825 Stockholders equity . . . . . . . . . . . . . . . . . . . . . . . . . . . 244,754 212,490 221,001 215,632 138,830 OTHER OPERATING DATA:
Net cash (used in) provided by operating activities . . . . . . . (27,357) (26,425) (9,062) 5,285 48,630 Net cash used in investing activities . . . . . . . . . . . . . . . . (25,316) (2,701) (14,055) (19,478) (30,864) Net cash provided by financing activities . . . . . . . . . . . . . 20,562 34,486 39,824 27,045 116,305 22 ITEM 7. MANAGEMENTS 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 report. The
discussion in this report 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
report should be read as applying to all related forward-looking statements wherever they appear in this
report. Our actual results could differ materially from those 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 Special Note Regarding Forward-Looking Statements. General Overview We are a leading facilities-based provider of low-cost, high-speed Internet access and IP communications services. Our network is specifically designed and optimized to transmit data using IP.
IP networks are significantly less expensive to operate and are able to achieve higher performance
levels than the traditional circuit-switched networks used by our competitors when providing Internet
access services, thus, we believe, giving us cost and performance advantages. We deliver our services to
small and medium-sized businesses, communications service providers and other bandwidth-intensive
organizations through approximately 15,000 customer connections in North America and Europe. Our
primary on-net service is Internet access at a speed of 100 Megabits per second, much faster than
typical Internet access currently offered to businesses. We offer this on-net service exclusively through
our own facilities, which run all the way to our customers premises. Our network is comprised of in-building riser facilities, metropolitan optical fiber networks, metropolitan traffic aggregation points and inter-city transport facilities. The network is physically
connected entirely through our facilities to over 1,215 buildings in which we provide our on-net
services, including over 910 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 integrated
network architecture, we are not dependent on local telephone companies to serve our on-net
customers. We emphasize the sale of on-net services because we believe we have a competitive
advantage in providing these services and our sales of these services generate higher gross profit
margins than our off-net and non-core 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 also provide certain
non-core services which are legacy services which we acquired and continue to support but do not
actively sell. We believe our key opportunity is provided by our high-capacity network, which provides us with the ability to add a significant number of customers to our network with minimal incremental costs.
Our focus is to add customers to our network in a way that maximizes its use and at the same time
provides us with a customer mix that produces profit margins. We are responding to this opportunity by
increasing our sales and marketing efforts including increasing our number of sales representatives. In
addition, we may add customers to our network through strategic acquisitions. We are expanding our network to locations that we believe can be economically integrated and represent significant concentrations of Internet traffic. One of our keys to developing a profitable
business will be to carefully match the expense of extending our network to reach new customers with
the revenue generated by those customers. 23 We believe the two of the most important trends in our industry are the continued growth in Internet traffic and a decline in Internet access prices. As Internet traffic continues to grow and prices
per unit of traffic continue to decline, we believe our ability to load our network and gain market share
from less efficient network operators will expand. However, continued erosion in Internet access prices
will likely have a negative impact on the rate at which we can increase our revenues and our profit
margins. Our on-net service consists of high-speed Internet access and IP connectivity ranging from 0.5 Megabits per second to 10 Gigabits 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 primarily by means of T1, T3, E1 and E3 and Ethernet link lines
obtained from other carriers. Our non-core services, which consist of legacy services of companies
whose assets or businesses we have acquired, include managed modem services, voice services (only
provided in Toronto, Canada) and point to point private line services. We do not actively market these
non-core services and expect the net service revenue associated with them to continue to decline. Due to our strategic acquisitions of network assets and equipment, we believe we are positioned to grow our revenue base. We continue to purchase and deploy network equipment to parts of our
network to maximize the utilization of our assets and to expand our network. Our future capital
expenditures will be based primarily on our planned expansion of our network, the addition of on-net
buildings and the concentration and growth of our customer base. We plan to continue to expand our
network and to increase our number of on-net buildings by approximately 100 buildings by
December 31, 2008 from 1,217 buildings at December 31, 2007. We expect our 2008 capital
expenditures to be similar to our 2007 capital expenditure rate, or approximately $30.0 million. Historically, our operating expenses have exceeded our net service revenue resulting in operating losses of $62.1 million, $46.6 million and $29.9 million in 2005, 2006 and 2007, respectively. In each of
these periods, our operating expenses consisted primarily of the following: Network operations expenses, which consist primarily of the cost of leased circuits, sites and facilities; telecommunications licenses, maintenance expenses, and salaries of, and expenses
related to, employees who are directly involved with the maintenance and operation of our
network. Selling, general and administrative expenses, which consist primarily of salaries, commissions and related benefits paid to our employees and related selling and administrative costs including
professional fees and bad debt expenses. Depreciation and amortization expenses, which result from the depreciation of our property and equipment, including the assets associated with our network and the amortization of intangible
assets. Equity-based compensation expenses that result from the grants of stock options and restricted stock. 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: net service revenues, which are an indicator of our overall business growth and the success of our sales and marketing efforts; gross profit, which is an indicator of both our service offering mix, competitive pricing pressures and the cost of our network operations; 24 growth in our on-net customer base, which is an indicator of the success of our on net focused sales efforts; growth in our on-net buildings; and cash flows. Year Ended December 31, 2006 Compared to the Year Ended December 31, 2007 The following summary table presents a comparison of our results of operations for the year ended December 31, 2005 and 2006 with respect to certain key financial measures. The comparisons
illustrated in the table are discussed in greater detail below. Year Ended December 31, Percent 2006 2007 Change (in thousands) Net service revenue . . . . . . . . . . . . . . . . . . . . . . . . . $149,071 $185,663 24.5% On-net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . 105,275 146,604 39.3% Off-net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . 34,416 32,123 (6.7)% Non-core revenues . . . . . . . . . . . . . . . . . . . . . . . . 9,380 6,936 (26.1)% Network operations expenses(1) . . . . . . . . . . . . . . . . 80,106 87,548 9.3% Gross profit(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68,965 98,115 42.3% Selling, general, and administrative expenses(3) . . . . . 46,593 52,011 11.6% Equity-based compensation expense . . . . . . . . . . . . . 10,509 10,384 (1.2)% Depreciation and amortization expenses . . . . . . . . . . 58,414 65,638 12.4% Gainslease obligations and asset sales . . . . . . . . . . . 509 2,205 333.2% Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (53,757) (31,025) 42.3% (1) Excludes equity-based compensation expense of $315 and $208 in the years ended December 31, 2006 and 2007, respectively, which, if included would have resulted in a
period-to-period change of 9.1%. (2) Excludes equity-based compensation expense of $315 and $208 in the years ended December 31, 2006 and 2007, respectively, which if included would have resulted in a
period-to-period change of 42.6%. (3) Excludes equity-based compensation expense of $10,194 and $10,176 in the years ended December 31, 2006 and 2007, respectively, which, if included would have resulted in a
period-to-period change of 9.5%. Net Service Revenue. Our net service revenue increased 24.5% from $149.1 million for the year ended December 31, 2006 to $185.7 million for the year ended December 31, 2007. The impact of
exchange rates resulted in approximately $4.2 million of the $36.6 million increase in revenues. For the
years ended December 31, 2006 and 2007, on-net, off-net and non-core revenues represented 70.6%,
23.1% and 6.3% and 79.0%, 17.3% and 3.7% of our net service revenues, respectively. Our on-net revenues increased 39.3% from $105.3 million for the year ended December 31, 2006 to $146.6 million for the year ended December 31, 2007. Our on-net revenues increased as we
increased the number of our on-net customer connections by 43.9% from approximately 7,800 at
December 31, 2006 to approximately 11,200 at December 31, 2007. On-net customer connections
increased at a greater rate than on-net revenues due to a decline in the revenue per on-net customer
connection. This decline is partly attributed to a shift in the customer connection mix. Due to the
increase in the size of our sales force, we are now able to focus not only on customers who purchase
high-bandwidth connections, as we have done historically, but also on customers who purchase lower- 25 bandwidth connections. We expect to continue to focus our sales efforts on a broad mix of customers.
Additionally, on-net customers who cancel their service, in general, have greater revenue per
connection than new customers. These trends and, to a lesser extent, an increase in customers receiving
a discount for purchasing longer term contracts, resulted in a reduction to our revenue per on-net
connection. We believe that our on-net revenues as a percentage of total revenues will continue to
increase as we are allocating the majority of our sales and marketing resources toward obtaining
additional on-net customers. Our off-net revenues decreased 6.7% from $34.4 million for the year ended December 31, 2006 to $32.1 million for the year ended December 31, 2007. Our off-net customer connections declined 15.4%
from approximately 3,500 at December 31, 2006 to approximately 3,000 at December 31, 2007. Off-net
customer connections decreased at a greater rate than the decline in off-net revenues due to an
increase in the revenue per off-net customer connection. Off-net customers who cancel their service, in
general, have revenue per connection that is less than new off-net customers who generally purchase
higher-bandwidth connections. Additionally, a significant amount of our off-net revenues were acquired
revenues, which have historically churned at a greater rate than our on-net revenues. We expect the
revenue from these off-net services to grow at a substantially slower rate than our on-net revenues as
we are allocating the majority of our sales and marketing resources toward obtaining additional on-net
customers. Our non-core revenues decreased 26.1% from $9.4 million for the year ended December 31, 2006 to $6.9 million for the year ended December 31, 2007. The number of our non-core customer
connections declined 20.3% from approximately 1,000 at December 31, 2006 to approximately 800 at
December 31, 2007. We do not actively market these acquired non-core services and expect that the net
service revenue associated with them will continue to decline. Network Operations Expenses. Our network operations expenses, excluding equity-based compensation expense, increased 9.3% from $80.1 million for the year ended December 31, 2006 to
$87.5 million for the year ended December 31, 2007. The increase is primarily attributable to an
increase in costs related to our network and facilities expansion activities partly offset by the decline in
network operations expenses associated with the decline in our off-net and non-core revenues. The
impact of exchange rates resulted in approximately $1.8 million of this $7.4 million increase in network
operations expenses. Gross Profit. Our gross profit, excluding equity-based compensation expense, increased 42.3% from $69.0 million for the year ended December 31, 2006 to $98.1 million for the year ended
December 31, 2007. We determine gross profit by subtracting network operation expenses, excluding
equity-based compensation expense, from our net service revenue and do not allocate depreciation and
amortization expense to our network operations expense. The increase is primarily attributed to the
increase in higher gross margin on-net revenues as a percentage of net service revenue. Our gross
profit margin expanded from 46.3% for the year ended December 31, 2006 to 52.8% for the year
ended December 31, 2007. Our gross profit has benefited from the limited incremental expenses
associated with providing service to an increasing number of on-net customers and the decline in
off-net revenues which carry a lower gross margin due to the associated leased circuit required to
provide this service. Our gross profit margin may be impacted by the timing and amounts of disputed
circuit costs and the additional costs of expanding our network and operating our existing network. We
generally record disputed circuit costs amounts when billed by the vendor and reverse these amounts
when the vendor credit has been received or the dispute has been otherwise resolved. We believe that
our gross profit margin will continue to increase as we are allocating the majority of our sales and
marketing resources toward obtaining additional on-net customers and as sales of these services
generate higher gross profit margins than our off-net and non-core services. 26 Selling, General, and Administrative Expenses (SG&A). Our SG&A expenses, excluding equity- based compensation expense, increased 11.6% from $46.6 million for the year ended December 31,
2006 to $52.0 million for the year ended December 31, 2007. SG&A expenses increased primarily from
the increase in salaries and related costs required to support our expanding sales and marketing efforts.
The impact of exchange rates resulted in approximately $1.4 million of this $5.4 million increase in
SG&A expenses. Equity-based Compensation Expense. Equity-based compensation expense is related to restricted stock and stock options. The total equity-based compensation expense decreased 1.2% from
$10.5 million for the year ended December 31, 2006 to $10.4 million for the year ending December 31,
2007. During 2007, we issued approximately 1.0 million shares of restricted stock to our employees.
These grants were valued at our closing stock price on the date of grant and will vest over periods
ranging from two to four years. These grants resulted in approximately $7.1 million in equity-based
compensation expense for the year ended December 31, 2007. The increase was partly offset by a
$6.8 million decrease in equity-based compensation expense associated with certain 2003 restricted
stock grants which ended in August 2006 when these shares became fully vested. As of December 31,
2007 there was approximately $22.6 million of total unrecognized compensation cost related to
non-vested equity-based compensation awards. That cost is expected to be recognized over a weighted
average period of approximately twenty-one months. Depreciation and Amortization Expenses. Our depreciation and amortization expense increased 12.4% from $58.4 million for the year ended December 31, 2006 to $65.6 million for the year ended
December 31, 2007 due to an increase in deployed fixed assets. Gainslease obligations and asset sales. In September 2007, we entered into a settlement agreement under which we were released from our obligation under an abandoned facility lease
acquired in an acquisition. This settlement agreement resulted in a gain of approximately $2.1 million.
In September 2006, Cogent Spain negotiated modifications to an IRU capital lease that reduced its
quarterly IRU lease payments and extended the lease term. The modification to this IRU capital lease
resulted in a gain of approximately $0.3 million. In 2006, we sold a building and land for net proceeds
of $0.8 million. This sale resulted in a gain of approximately $0.3 million. Net Loss. Our net loss was $53.8 million for the year ended December 31, 2006 as compared to a net loss of $31.0 million for the year ended December 31, 2007. Our net loss decreased by
$22.7 million primarily due to a $29.2 million increase in our gross profit partially offset by a
$5.4 million increase in SG&A, and a $7.2 million increase in depreciation and amortization expense.
Included in net loss for the year ended December 31, 2006 are gains of approximately $0.5 million.
Included in net loss for the year ended December 31, 2007 are gains of approximately $2.2 million. Buildings On-net. As of December 31, 2006 and 2007 we had a total of 1,107 and 1,217 on-net buildings connected to our network, respectively. We plan to increase our number of on-net buildings
by approximately 100 buildings by December 31, 2008. 27 Year Ended December 31, 2005 Compared to the Year Ended December 31, 2006 The following summary table presents a comparison of our results of operations for the year ended December 31, 2005 and 2006 with respect to certain key financial measures. The comparisons
illustrated in the table are discussed in greater detail below. Year Ended December 31, Percent 2005 2006 Change (in thousands) Net service revenue . . . . . . . . . . . . . . . . . . . . . . . . . $135,213 $149,071 10.2% On-net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . 78,324 105,275 34.4% Off-net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . 44,642 34,416 (22.9)% Non-core revenues . . . . . . . . . . . . . . . . . . . . . . . . 12,245 9,380 (23.4)% Network operations expenses(1) . . . . . . . . . . . . . . . . 85,794 80,106 (6.6)% Gross profit(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49,419 68,965 39.6% Selling, general, and administrative expenses(3) . . . . . 41,344 46,593 12.7% Lease restructuring charge . . . . . . . . . . . . . . . . . . . . 1,319 (100.0)% Equity-based compensation expense . . . . . . . . . . . . . 13,305 10,509 (21.0)% Depreciation and amortization expenses . . . . . . . . . . 55,600 58,414 5.1% Gainslease obligations, debt restructurings and asset sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,058 509 (89.9)% Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (67,518) (53,757) 20.4% (1) Excludes equity-based compensation expense of $399 and $315 in the years ended December 31, 2005 and 2006, respectively, which, if included would have resulted in a
period-to-period change of (6.7)%. (2) Excludes equity-based compensation expense of $399 and $315 in the years ended December 31, 2005 and 2006, respectively, which if included would have resulted in a
period-to-period change of 40.0%. (3) Excludes equity-based compensation expense of $12,906 and $10,194 in the years ended December 31, 2005 and 2006, respectively, which, if included would have resulted in a
period-to-period change of 4.7%. Net Service Revenue. Our net service revenue increased 10.2% from $135.2 million for the year ended December 31, 2005 to $149.1 million for the year ended December 31, 2006. For the years
ended December 31, 2005 and 2006, on-net, off-net and non-core revenues represented 57.9%, 33.0%
and 9.1% and 70.6%, 23.1% and 6.3% of our net service revenues, respectively. Our on-net revenues increased 34.4% from $78.3 million for the year ended December 31, 2005 to $105.3 million for the year ended December 31, 2006. Our on-net revenues increased as we increased
the number of our on-net customer connections from approximately 4,700 at December 31, 2005 to
approximately 7,800 at December 31, 2006. On-net customer connections increased at a greater rate
than on-net revenues due to a decline in the revenue per on-net customer connection. This decline is
partly attributed to a shift in the customer connection mix. Due to the increase in the size of our sales
force, we focused not only on customers who purchase high-bandwidth connections, as we have done
historically, but also on customers who purchase lower-bandwidth connections. We expect to continue
to focus our sales efforts on such a broad mix of customers. Additionally, on-net customers who cancel
their service from our installed base of customers, in general, have revenue per connection that is
larger than new customers. These trends resulted in a reduction to our revenue per on-net connection. 28 Our off-net revenues decreased 22.9% from $44.6 million for the year ended December 31, 2005 to $34.4 million for the year ended December 31, 2006 primarily because a December 2004 acquisition
of off-net customers resulted in a substantial increase in the number of our off-net customers in 2005
and many of these acquired customers either cancelled service or re-priced their contracts at lower
rates. Our off-net customer connections declined from approximately 4,000 at December 31, 2005 to
approximately 3,500 at December 31, 2006. Our non-core revenues decreased 23.4% from $12.2 million
for the year ended December 31, 2005 to $9.4 million for the year ending December 31, 2006. The
number of our non-core customer connections declined from approximately 1,300 at December 31,
2005 to approximately 1,000 at December 31, 2006. We do not actively market these acquired non-core
services. Network Operations Expenses. Our network operations expenses, excluding equity-based compensation expense, decreased 6.6% from $85.8 million for the year ended December 31, 2005 to
$80.1 million for the year ended December 31, 2006. The decrease is primarily attributable to a decline
in leased circuit costs related to the decline in off-net revenues. We provide Internet connectivity to our
off-net customers using other carriers facilities to provide the last mile portion of the link from our
customers premises to our network and incur leased circuit costs to provide these services. Gross Profit. Our gross profit, excluding equity-based compensation expense, increased 39.6% from $49.4 million for the year ended December 31, 2005 to $69.0 million for the year ended
December 31, 2006. We determine gross profit by subtracting network operations expenses, excluding
equity-based compensation expense, from our net service revenue and do not allocate depreciation and
amortization expense to our network operations expense. The increase is primarily attributed to the
increase in higher gross margin on-net revenues as a percentage of net service revenue. Our gross
profit margin expanded from 36.5% for the year ended December 31, 2005 to 46.3% for the year
ended December 31, 2006. Our gross profit has benefited from the limited incremental expenses
associated with providing service to an increasing number of on-net customers and the decline in
off-net revenues which carry a lower gross margin due to the associated leased circuit required to
provide this service. Our gross profit margin may be impacted by the timing and amounts of disputed
circuit costs. We generally record these disputed amounts when billed by the vendor and reverse these
amounts when the vendor credit has been received or the dispute has been otherwise resolved. Selling, General, and Administrative Expenses (SG&A). Our SG&A expenses, excluding equity- based compensation expense, increased 12.7% from $41.3 million for the year ended December 31,
2005 to $46.6 million for the year ended December 31, 2006. SG&A expenses increased primarily from
the increase in salaries and related costs required to support our expanding sales and marketing efforts. Equity-based Compensation Expense. Equity-based compensation expense is related to restricted stock and stock options. The total equity-based compensation expense decreased 21.0% from
$13.3 million for the year ended December 31, 2005 to $10.5 million for the year ending December 31,
2006. The decrease is primarily attributed to a $3.4 million decrease in equity-based compensation
expense associated with certain 2003 restricted stock grants which ended in August 2006 when these
shares became fully vested. Equity-based compensation expense for the year ended December 31, 2006
includes $0.7 million in compensation costs associated with the adoption of Statement No. 123 (revised
2004), Share-Based Payment (SFAS 123(R)) on January 1, 2006 using the modified-prospective-
transition method. Depreciation and Amortization Expenses. Our depreciation and amortization expense increased 5.1% from $55.6 million for the year ended December 31, 2005 to $58.4 million for the year ended
December 31, 2006 due to an increase in deployed fixed assets. In the fourth quarter of 2005, we
revised the number of lease renewal periods used in determining the lease term for purposes of
amortizing certain of our leasehold improvements. This resulted in a net increase in depreciation
expense of approximately $3.0 million. 29 Lease restructuring charge. In 2004, we abandoned the Paris office obtained in our Cogent Europe acquisition and located these operations in another Cogent Europe facility. In 2005, we revised our
estimate for sublease income, and recorded an additional $1.3 million restructuring charge. Gainslease obligations, asset sales and debt restructurings. In September 2005, Cogent Spain negotiated modifications to an IRU capital lease that reduced its quarterly IRU lease payments and
extended the lease term. The modification to the IRU capital lease resulted in a gain of approximately
$0.8 million. In June 2005, we repaid our $17.0 million amended and restated Cisco note. The
repayment resulted in a gain of $0.8 million representing the amount of the estimated future interest
payments that were not required to be paid. In 2005, we sold a building and land for net proceeds of
$5.1 million. This sale resulted in a gain of approximately $3.9 million. In September 2006, Cogent Spain negotiated modifications to an IRU capital lease that reduced its quarterly IRU lease payments and extended the lease term. The modification to this IRU capital lease
resulted in a gain of approximately $0.3 million. In 2006, we sold another building and land for net
proceeds of $0.8 million. This sale resulted in a gain of approximately $0.3 million. Net Loss. Our net loss was $67.5 million for the year ended December 31, 2005 as compared to a net loss of $53.8 million for the year ended December 31, 2006. Our net loss decreased by
$13.8 million primarily due to a $19.5 million increase in our gross profit partially offset by a
$5.2 million increase in SG&A, and a $2.8 million increase in depreciation and amortization expense.
Included in net loss for the year ended December 31, 2005 is a $1.3 million lease restructuring charge
and gains of approximately $5.1 million. Included in net loss for the year ended December 31, 2006 are
gains of approximately $0.5 million. Buildings On-net. As of December 31, 2005 and 2006 we had a total of 1,040 and 1,107 on-net buildings connected to our network, respectively. Liquidity and Capital Resources In assessing our liquidity, management reviews and analyzes our current cash balances, short-term investments, accounts receivable, accounts payable, accrued liabilities, capital expenditure commitments,
and required capital lease and debt payments and other obligations. Cash Flows The following table sets forth our consolidated cash flows for the years ended December 31, 2005, 2006, and 2007. Year Ended December 31, 2005 2006 2007 (in thousands) Net cash (used in) provided by operating activities . $ (9,062) $ 5,285 $ 48,630 Net cash used in investing activities . . . . . . . . . . . . (14,055) (19,478) (30,864) Net cash provided by financing activities . . . . . . . . . 39,824 27,045
Download Cogent Communications Group Form 10-K.pdf
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