Cogent Communications Group, Inc. — Q1 2012 Form 10-Q
Business and period: The filing covers the three months ended March 31, 2012, compared with the three months ended March 31, 2011. Cogent provides IP-based Internet access and communications services in North America and Europe and reported that it had begun expanding into Japan. The company operates as one segment.
Financial performance
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Service revenue | $76.9 million | $73.5 million | +4.7% |
| Operating income | $6.0 million | $7.4 million | Lower |
| Operating margin | 7.8% | 10.0% | Lower |
| Net income (loss) | ($2.1 million) | ($0.3 million) | Loss increased |
| Operating cash flow | $12.7 million | $13.5 million | Lower |
| Capital expenditures | $12.3 million | $12.8 million | Lower |
Gross margin and EBITDA are not presented as clear values in the filing. Interest expense rose 18.6% to $9.0 million, reflecting the Senior Notes being outstanding for more of the comparable period and higher capital lease obligations. The company reported an income tax benefit of $0.6 million, including a $0.7 million reversal of uncertain-tax-position liabilities following resolution of state tax matters.
Revenue and operating trends
- On-net revenue was essentially flat at $56.8 million; off-net revenue rose 22.3% to $19.5 million, while non-core revenue declined 13.6% to $0.6 million.
- Corporate-customer revenue increased 8.2% to $39.1 million; net-centric revenue increased 1.3% to $37.8 million. North American revenue increased to $61.7 million from $57.3 million, while European revenue fell to $15.1 million from $16.2 million.
- On-net connections grew 20.0% to approximately 26,200, but on-net revenue was flat as average revenue per connection declined. Off-net connections rose 8.8% to approximately 3,960.
- Network operations expenses, excluding equity compensation, rose 8.3%; SG&A excluding equity compensation rose 14.8%, including approximately $1.5 million more bad-debt expense, primarily associated with the lost largest customer.
Liquidity, debt and cash flow
At March 31, 2012, cash and cash equivalents were $232.3 million, current assets $269.5 million and current liabilities $45.5 million. Total indebtedness, net of discount, was $386.1 million, including $175.0 million of 8.375% Senior Secured Notes, $78.0 million carrying value of Convertible Notes, and $133.1 million of capital lease obligations. The notes mature in 2018 and 2027, respectively; the convertible notes have a 2014 holder put date. Cash declined $5.9 million during the quarter. Financing cash outflow included $7.1 million of capital-lease principal payments; the prior-year period included $170.5 million net proceeds from the Senior Notes issuance.
Management said existing cash and cash generated from operations should meet working-capital, capital-expenditure and debt-service needs if the company executes its plan. It cautioned that acquisitions or other unplanned needs could require new financing, which may be unavailable on acceptable terms.
Outlook, risks and notable items
- The largest on-net, net-centric customer was indicted by the U.S. government and service ended in January 2012. It represented approximately 5.5% of 2011 and Q1 2011 revenue; management said its loss would weigh on 2012 revenue growth.
- Management sees opportunity in traffic growth, network utilization and expanding on-net buildings, but warned that declining Internet-access prices could pressure revenue growth and profitability. Network expansion and customer additions depend on access rights, fiber availability and equipment.
- Disclosed risks include competition and pricing, foreign-exchange movements, new-market execution, regulation, peering arrangements, dependence on Cisco equipment and third-party fiber, network disruptions, customer concentration and litigation.
- On April 19, 2012, the board decided to begin a planned quarterly dividend of $0.10 per share, approximately $18 million annually, subject to later approval and board discretion. The Senior Notes indenture limits dividends and other restricted payments.
- In Q2 2012, the company granted approximately 0.9 million restricted shares to senior management, valued at approximately $16.8 million, to be expensed over three to four years. The filing also reports $3.0 million of uncertain-tax-position liabilities and anticipates a potential further decrease of approximately $2.0 million during 2012 as statutes expire.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. It did not expect ordinary-course legal matters to materially affect operations or results.
Important facts for investors to verify
- Whether customer replacement and new sales offset the terminated large customer, and how on-net revenue per connection and pricing evolve.
- Whether expense growth, bad debts and interest costs continue to pressure operating margins and earnings.
- Capital spending, lease principal and semiannual note interest requirements relative to operating cash flow and the planned dividend.
- Dividend approval and payment, compliance with debt covenants, and the timing and accounting impact of the $16.8 million management share award.
- Potential tax-liability changes and the effect of currency movements, competition, regulation and network-expansion costs.