Cogent Communications Group, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet comparisons are with December 31, 2013. The filing identifies the registrant as Cogent Communications Group, Inc.
Business context
Cogent provides high-speed Internet access and IP communications services to businesses, communications providers, and other bandwidth-intensive customers in North America, Europe, and Japan. It emphasizes on-net services delivered over its own facilities; off-net services use other carriers for customer connections. The company operated as one segment and reported 2,024 on-net buildings at quarter-end, versus 1,890 a year earlier.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Service revenue | $92.9 million | $84.6 million | +9.9% |
| Operating income | $12.9 million | $9.9 million | +30.3% |
| Operating margin | 13.9% | 11.7% | +2.2 percentage points |
| Income before tax | $1.7 million | $0.7 million | Higher |
| Income tax expense | $1.6 million | $0.3 million | Higher |
| Net income | $0.1 million | $0.4 million | Lower |
| Operating cash flow | $10.6 million | $15.0 million | Lower |
| Capital expenditures | $15.6 million | $16.3 million | Lower |
On-net revenue grew 12.0% to $69.1 million; off-net revenue rose 5.3% to $23.5 million; non-core revenue declined 37.8% to $0.4 million. Corporate-customer revenue rose 11.4% to $47.9 million, and net-centric revenue rose 8.4% to $45.1 million. Customer connections grew faster than revenue: on-net connections increased 17.4% to 36,306 and off-net connections increased 14.2% to 5,244. On-net ARPU fell 4.1% to $649, off-net ARPU fell 7.7% to $1,516, and average price per megabit declined 24.9% to $2.15.
Network operations expense increased 4.1% to $38.8 million; selling, general and administrative expense increased 22.5% to $26.3 million; depreciation and amortization increased 8.4% to $17.2 million. Interest expense rose 14.5% to $11.3 million, reflecting additional notes, higher capital-lease obligations, and convertible-note discount amortization. The filing attributes SG&A growth mainly to higher staffing and sales and expansion costs. Foreign losses produced no corresponding tax benefit, contributing to the effective tax-rate difference from the statutory rate.
Liquidity, cash flow, and debt
Cash and cash equivalents were $263.7 million at March 31, 2014, down from $304.9 million at year-end. Current assets were $320.7 million and current liabilities $142.3 million; working capital was approximately $178.3 million. Operating cash flow was $10.6 million, while investing cash use was $15.6 million and financing cash use was $35.8 million. Financing outflows included $18.4 million of dividends, $14.2 million of share repurchases, and $3.4 million of capital-lease principal payments. Cash decreased $41.1 million during the quarter.
Reported total indebtedness, net of discount, was $498.0 million, including $162.4 million of capital-lease obligations. The balance sheet showed $90.6 million of current convertible notes, $245.1 million of senior secured notes, and $162.4 million of capital leases. Management said cash on hand and operating cash generation should be adequate for planned requirements if the company executes its business plan.
Material changes, outlook, and notable items
- Revenue and operating income increased, but net income remained minimal as interest and tax expense absorbed most of operating income. Operating cash flow declined, primarily because of increased prepayments for annual-term agreements.
- Prices and ARPU declined even as connections expanded. Management said continued Internet-traffic growth and network utilization may support growth, but price erosion could constrain revenue growth and profitability. European operations continued to incur losses pending greater scale.
- On April 9, 2014, a financing subsidiary issued $200 million of 5.625% senior notes due 2021, with approximately $196 million net proceeds deposited in escrow. Release was conditional, including completion of the planned convertible-note redemption and merger steps by June 30, 2014; otherwise, the notes were subject to special mandatory redemption. The company stated its intent to redeem the approximately $92 million of convertible notes on or about June 20, 2014.
- The company paid a Q1 dividend of $0.39 per share, including the additional capital-return component. A regular Q2 dividend of $0.17 per share was approved after quarter-end; the filing estimated a $7.9 million payment. Future dividends and capital returns remain subject to board discretion and financial conditions.
- The board’s $50 million buyback program included $14.2 million of Q1 purchases; an additional $8.5 million was spent in April. The filing gives conflicting remaining-authorization amounts in different sections.
- In a network-equipment exchange, Cogent recorded a $2.2 million gain. The filing also describes potential additional loss of up to $1.9 million beyond accruals for leased-circuit and dark-fiber matters. A sales-employee overtime collective action was decertified in March 2014; approximately 50 former employees had filed individual actions. The company disputes the claims.
- Management identified risks including competition and pricing pressure, customer retention, peering terms, reliance on Cisco equipment and third-party fiber, network disruptions, foreign exchange, regulation, and litigation. It gave no quantified full-year guidance.
Important facts for investors to verify
- Whether the 2021-note escrow conditions were met, the refinancing and merger were completed, and the convertible notes were redeemed as planned.
- The remaining buyback authorization: the filing variously reports approximately $31.6 million, $36.1 million, and $25.8 million at or around March 31, 2014; it reports $23.1 million at April 30 after April purchases.
- The potential financial exposure from leased-circuit and dark-fiber disputes and the individual overtime lawsuits.
- Whether connection growth can continue to offset falling ARPU and price per megabit, particularly as European operations remain loss-making.
- The sustainability of dividends and repurchases relative to operating cash flow, capital spending, and debt service.