Business context and reporting period
Cogent Communications Group, Inc. and subsidiaries (the registrant named in the filing) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2013. Cogent provides facilities-based Internet access and IP communications services to business and bandwidth-intensive customers in North America, Europe and Japan.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Service revenue | $87.8 million | $79.7 million | $258.1 million | $234.4 million |
| Operating income | $12.6 million | $8.0 million | $34.1 million | $21.8 million |
| Operating margin | 14.3% | 10.1% | 13.2% | 9.3% |
| Net income (loss) | $2.1 million | $(0.1) million | $4.1 million | $(4.0) million |
| Interest expense | $10.6 million | $9.0 million | $30.7 million | $27.0 million |
- For the nine months, operating cash flow was $52.6 million; capital expenditures were $38.9 million, leaving approximately $13.6 million after those expenditures. Cash increased $57.5 million to $304.8 million.
- At September 30, cash was $304.8 million and total indebtedness, net of discount and including premium, was $490.3 million, including $157.4 million of capital lease obligations. Current assets were $346.3 million and current liabilities $131.9 million.
- Revenue grew 10.2% in Q3 and 10.1% year to date. On-net revenue rose 11.0% in Q3 and 9.7% year to date; off-net revenue rose 8.9% and 12.3%, respectively. Non-core revenue continued to decline.
- Q3 diluted earnings per share were $0.05; nine-month diluted earnings per share were $0.09. Dividends declared were $0.14 per share for Q3 and $0.39 per share for the first nine months.
Material changes versus comparable periods
- Revenue growth and lower relative growth in operating expenses lifted operating income and margins; net income shifted from a loss in 2012 to profit in 2013 for both periods.
- Interest expense increased 17.2% in Q3 and 13.5% year to date, reflecting the August 2013 notes issuance, higher capital lease obligations and convertible-note discount amortization.
- On-net connections increased 15.5% year over year to approximately 33,300, while on-net revenue grew more slowly, partly because average revenue per connection declined amid pricing discounts and customer mix. Off-net connections increased 14.7% to approximately 4,890.
- In August 2013, Cogent issued $65.0 million of 8.375% senior secured notes due February 2018 at 109% of par, receiving approximately $69.9 million net proceeds. The $91.978 million principal amount of 1.00% convertible notes was classified as current because holders’ earliest put date is June 2014.
- Cash from operations increased to $52.6 million from $47.6 million. Capital expenditures were $38.9 million versus $34.1 million; dividends paid were $18.1 million versus $4.5 million.
Outlook, risks and contingencies
- Management said cash on hand and operating cash generation should be adequate for working capital, capital expenditures, debt service and dividends if the company executes its business plan. Additional funding may be needed for acquisitions or significant unplanned costs; financing may not be available on acceptable terms.
- Management sees growth potential in using network capacity and expanding buildings and markets, while noting that price-per-megabit declines may constrain revenue and profitability. European operations have incurred losses and may continue to do so until they reach sufficient scale.
- Risks cited include competition and pricing pressure, customer and traffic growth, peering arrangements, reliance on Cisco equipment and third-party fiber, network disruptions, foreign exchange, regulation, and litigation.
- The company disclosed sales-employee wage-and-hour claims in federal and California proceedings, which it denies and considers without merit. Disputed leased-circuit and dark-fiber positions could result in up to $1.8 million of loss beyond amounts accrued. Management did not expect other ordinary-course legal matters to materially affect results, but outcomes remain uncertain.
- The board approved an additional capital-return program targeting at least $10 million per quarter, in addition to regular dividends. A December 2013 payment totaling $0.37 per share was approved; future returns remain at the board’s discretion.
- Management reported disclosure controls were effective at a reasonable-assurance level and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Timing and outcome of the convertible notes’ June 2014 put right, and the company’s plan to fund any repurchase.
- Debt service and refinancing capacity, including capital leases and the 8.375% notes due in 2018.
- Whether connection growth can offset declining average revenue per on-net connection and ongoing price pressure.
- Capital spending, operating cash generation, and the sustainability of regular dividends and the additional capital-return program.
- Developments in the wage-and-hour cases and the leased-circuit and dark-fiber contingency.