Cogent Communications Group, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2012. The interim financial statements are unaudited. Cogent provides facilities-based Internet access and IP communications services to business and bandwidth-intensive customers in North America and Europe, and had recently begun expanding into Japan. The filing reports one operating segment.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Service revenue | $79.7 million | $77.4 million | $234.4 million | $226.4 million |
| Operating income | $8.0 million | $9.6 million | $21.8 million | $25.6 million |
| Operating margin | 10.1% | 12.4% | 9.3% | 11.3% |
| Net income (loss) | $(0.1) million | $0.3 million | $(4.0) million | $2.1 million |
| Operating cash flow | Not separately reported | Not separately reported | $47.6 million | $48.5 million |
| Capital expenditures | Not separately reported | Not separately reported | $34.1 million | $35.4 million |
For the nine months, service revenue rose 3.5%, while operating expenses increased faster, by 5.9%; operating income declined 14.9%. Interest expense was $27.0 million, up 5.2%. Results in 2011 included a $2.7 million gain from release of a lease obligation, which did not recur in 2012. The 2012 nine-month income tax benefit included a $2.6 million reversal of uncertain tax liabilities.
At September 30, 2012, cash and cash equivalents were $232.1 million, current assets $271.1 million, and current liabilities $42.1 million. Total assets were $592.9 million and stockholders’ equity was $161.0 million. Total indebtedness, net of discount, was $387.3 million, including $131.3 million of capital lease obligations; it comprised $175.0 million of 8.375% secured notes, $81.0 million carrying value of convertible notes, and capital leases. Cash declined $6.1 million in the first nine months. Operating cash flow less capital expenditures was approximately $13.6 million.
Changes and operating trends
- Q3 revenue increased 3.0%; nine-month revenue increased 3.5%. Foreign exchange reduced reported revenue by approximately $2.2 million in Q3 and $5.1 million for the nine-month period.
- On-net revenue fell 1.0% in Q3 and 0.7% for nine months, despite a 17.5% increase in on-net connections year over year. Management attributed pressure partly to lower average revenue per connection, pricing discounts, foreign exchange, and loss of a major customer.
- Off-net revenue grew 16.4% in Q3 and 18.9% for nine months, alongside 10.2% growth in off-net connections. Network operations costs also rose, partly from expansion and off-net circuit costs.
- Corporate-customer revenue grew 11.0% in Q3 and 9.3% for nine months; net-centric revenue declined 4.7% and 2.0%, respectively. Europe revenue fell year over year, while North American revenue increased.
- Network operations expense, excluding equity compensation, increased 8.6% in Q3 and 7.5% for nine months. Nine-month SG&A excluding equity compensation rose 5.7%, including higher sales and marketing costs and approximately $1.5 million more bad-debt expense.
Outlook, risks, and notable items
- Management said cash on hand and operating cash generation should meet working capital, capital expenditure, debt service, dividend, and other needs if the company executes its business plan. No quantified revenue or earnings guidance was provided.
- Management plans continued network expansion, building additions, and sales and marketing investment. It cautioned that financing may be needed for acquisitions or significant unplanned costs; unavailable or unfavorable financing could require scaling back expansion or changing the business plan.
- The company lost its largest net-centric, on-net customer in January 2012 after the customer was indicted by the U.S. government. That customer represented approximately 5.5% of 2011 revenue; management said the loss would weigh on 2012 growth. On-net revenue per connection also declined.
- Disclosed risks include competition and price erosion, customer and traffic growth, peering arrangements, reliance on Cisco equipment and third-party fiber providers, network disruptions, foreign-exchange movements, new-market execution, regulation, and litigation.
- A leased-circuit dispute could result in up to $1.1 million of loss in excess of the amount accrued. Management said ordinary-course legal matters were not expected to materially affect results. Uncertain tax benefits, including interest and penalties, were approximately $1.6 million at quarter-end; management expected a further reduction of about $0.8 million in Q4 from statute expirations.
- The company paid a $0.10-per-share dividend in September and announced a $0.11-per-share dividend for December, estimated at approximately $5.0 million. Future dividends remain at the board’s discretion and are subject to debt-indenture restrictions. Approximately $45.8 million remained under the $50.0 million share repurchase authorization.
- In Q2, the company granted approximately 1.2 million restricted shares with a grant-date value of about $22.0 million, to be expensed over three to four years. The CEO and his wife own the entity leasing the company’s headquarters; the lease was extended through August 31, 2015.
Important facts for investors to verify
- Whether customer additions and off-net growth can offset the lost major customer, declining on-net revenue per connection, and price pressure.
- Expected network expansion spending, capital lease commitments, and the company’s ability to sustain cash generation after debt interest, lease payments, and dividends.
- Debt covenants and restrictions on dividends and repurchases, including the secured notes’ 8.375% coupon and convertible notes’ 2014 holder put date.
- Resolution and final exposure for the leased-circuit contingency, uncertain tax positions, and any material legal proceedings.
- Actual recurring performance excluding foreign-exchange effects and the nonrecurring 2011 lease-obligation gain and 2012 tax-liability reversals.