Cogent Communications Group, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2012; comparative periods are the corresponding periods of 2011. The filing reports unaudited consolidated results. Cogent provides high-speed Internet access and IP communications services, primarily in North America and Europe, and recently began expanding into Japan.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Service revenue | $77.8 million | $75.6 million | $154.7 million | $149.0 million |
| Operating income | $7.8 million | $8.7 million | $13.8 million | $16.0 million |
| Operating margin | 10.0% | 11.5% | 8.9% | 10.8% |
| Net income (loss) | $(1.8) million | $2.1 million | $(3.9) million | $1.8 million |
| Operating cash flow | Not separately presented for the quarter | $32.2 million | $32.6 million | |
| Capital expenditures | Not separately presented for the quarter | $22.9 million | $26.0 million |
Six-month operating cash flow less capital expenditures was approximately $9.3 million, compared with $6.6 million in 2011. This is a simple calculation from reported cash flows, not a company-defined measure. The filing does not report EBITDA or a gross margin figure.
At June 30, cash and cash equivalents were $237.2 million, current assets $274.7 million, and current liabilities $46.0 million. Working capital was approximately $228.8 million and the current ratio approximately 6.0x, calculated from reported balances. Total indebtedness, net of discount, was $386.1 million, including $131.6 million of capital lease obligations; cash less this debt implies net debt of approximately $148.8 million. Debt included $175.0 million of 8.375% secured notes and $92.0 million principal amount of 1.00% convertible notes. The convertible notes’ balance-sheet carrying value was $79.5 million.
Material changes and management commentary
- Revenue increased 3.0% in Q2 and 3.8% for the first half. Foreign-exchange movements reduced reported revenue by approximately $2.1 million and $2.7 million, respectively, on management’s constant-currency comparison.
- Growth was uneven across services. Q2 on-net revenue fell 1.2% to $57.3 million, while off-net revenue rose 18.4% to $19.9 million; non-core revenue declined 19.3% to $0.6 million. For the first half, on-net revenue fell 0.6%, off-net rose 20.3%, and non-core fell 16.4%.
- Corporate-customer revenue grew 8.6% in Q2 and 8.4% in the first half. Net-centric revenue declined 2.5% and 0.6%, respectively. The company attributed pressure partly to the January 2012 loss of its largest on-net, net-centric customer, which represented approximately 5.5% of 2011 and comparable-period 2011 revenue.
- On-net connections increased 17.6% year over year to approximately 27,500, and connected buildings rose to 1,799 from 1,669. Revenue growth lagged connection growth as average revenue per on-net connection declined, including due to pricing discounts and the mix of new and departing customers. Off-net connections increased 9.1% to approximately 4,100.
- Operating income and margins weakened despite revenue growth. For the first half, network operations expense excluding equity compensation increased 6.9%, SG&A excluding equity compensation increased 8.8%, and depreciation and amortization increased 4.1%. Management cited network expansion, off-net circuit costs, sales and marketing investment, and approximately $1.3 million of additional bad-debt expense related primarily to the lost customer.
- Interest expense rose 7.5% in the first half to $18.0 million, mainly because the senior notes were outstanding for only part of the prior-year comparison period and capital lease obligations increased. The 2011 comparison also included a $2.7 million gain from release of an impaired lease obligation; there was no such gain in 2012.
Liquidity, outlook, risks, and notable items
- Management said cash on hand and operating cash generation should be adequate for working capital, capital expenditures, debt service, and other requirements if the company executes its business plan. It cautioned that acquisitions or other unplanned needs could require additional debt or equity financing; availability and terms are not assured.
- Management intends to continue network expansion, add on-net buildings, and increase sales and marketing efforts, while matching network-extension costs with expected revenue. No quantified revenue, earnings, or cash-flow guidance is provided.
- Risks identified include economic weakness, foreign-exchange fluctuations, competition and pricing pressure, customer concentration and retention, growth in network traffic, peering arrangements, reliance on Cisco equipment and third-party fiber, network disruptions, regulatory changes, and challenges in new markets.
- The company granted approximately 1.2 million restricted shares in Q2, with a reported grant-date fair value of approximately $22.0 million to be expensed over three to four years. It also repurchased approximately 74,600 shares in May for about $1.3 million; $45.8 million remained under its $50.0 million authorization at quarter-end.
- After quarter-end, the board approved a $0.10-per-share dividend, estimated at approximately $4.7 million, payable September 12, 2012. Future dividends remain discretionary and subject to financial and other factors and debt restrictions.
- Unrecognized tax-benefit liability, including accrued interest and penalties, was approximately $3.1 million at June 30. Management expected it to decline by about $2.0 million during the following 12 months as statutes of limitation expired, but actual changes could differ. A separate $0.7 million uncertain-tax-position liability was reversed in Q1 after resolution of a state tax audit.
- Management stated that ordinary-course legal matters were not expected to have a material impact. The filing also discloses a related-party headquarters lease: the building partnership is owned by the CEO and his wife, and the lease was due to expire in August 2013.
Investor facts to verify
- Whether customer additions and off-net growth can offset the lost major customer and declining average revenue per on-net connection.
- Whether expense growth, capital spending, and debt-service costs allow operating margins and cash generation to improve.
- The impact of the $22.0 million restricted-stock grant on future compensation expense and dilution.
- Debt-document limits on dividends and buybacks, alongside the planned dividend, remaining repurchase authorization, and capital requirements.
- Actual resolution of uncertain tax positions and any material developments in litigation, regulatory exposure, or network and supplier risks.