Cogent Communications Group, Inc. — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. The filing also provides unaudited fourth-quarter results. Cogent provides IP-focused Internet access and communications services, primarily to businesses, carriers and bandwidth-intensive customers in North America, Europe and Japan.
Financial performance and liquidity
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Service revenue | $348.0 million | $317.0 million | +9.8% |
| Operating income | $46.2 million | $31.0 million | +49.0% |
| Operating margin | 13.3% | 9.8% | +3.5 percentage points |
| Income (loss) before tax | $7.0 million | $(3.5) million | Improved |
| Net income (loss) | $56.7 million | $(4.3) million | Improved |
| Diluted EPS | $1.21 | $(0.09) | Improved |
| Operating cash flow | $81.9 million | $79.9 million | +2.4% |
| Capital expenditures | $49.0 million | $44.3 million | +10.6% |
| Cash and cash equivalents, year-end | $304.9 million | $247.3 million | +$57.6 million |
| Total debt, including capital leases, net of discount | $496.1 million | $395.4 million | +$100.6 million |
Operating cash flow less capital expenditures was approximately $32.8 million in 2013 (calculated). Year-end current assets were $354.3 million and current liabilities were $143.7 million. Total assets were $755.1 million; stockholders’ equity was $193.5 million. The $496.1 million debt figure includes $161.8 million of capital lease obligations. Cash exceeded reported debt by approximately $191.2 million (calculated), but does not remove upcoming debt and contractual payment obligations.
Business trends and changes from the prior year
- On-net revenue rose 9.6% to $255.0 million; on-net connections grew 16.1% to 34,671. Off-net revenue increased 11.2% to $91.1 million; connections grew 14.0% to 5,088.
- Pricing continued to decline: average price per megabit fell 22.9%, on-net ARPU declined 5.9%, and off-net ARPU declined 2.4%. Revenue growth therefore lagged connection growth.
- On-net service generated 73.3% of service revenue and is management’s focus because it generally has higher gross margins. Non-core revenue fell 22.4% to $1.9 million.
- Network operations expense rose 4.6% to $150.2 million; SG&A rose 9.2% to $87.2 million; depreciation and amortization rose 3.0% to $64.4 million. Interest expense increased 15.1% to $41.8 million.
- The $56.7 million net profit was substantially affected by a $49.7 million income tax benefit, primarily from releasing valuation allowances on certain U.S. deferred tax assets. Pre-tax income was $7.0 million; the tax benefit is not an operating revenue or cash-flow measure.
- Fourth-quarter revenue was $89.9 million and operating income was $12.1 million. Fourth-quarter net income of $52.6 million included the deferred-tax valuation-allowance reversal.
Debt, capital returns and outlook
- In August 2013, Cogent issued $65.0 million of 8.375% secured notes due February 2018, bringing secured notes outstanding to $240.0 million. These notes require $20.1 million of annual interest payments. The company also had $92.0 million face value of 1.00% convertible notes, with holders able to require cash repurchase on June 15, 2014.
- Contractual cash obligations totaled $1.19 billion, including debt, capital leases, operating leases and purchase obligations; $228.1 million was scheduled within one year. Management said cash on hand and operating cash flow should meet requirements if the business plan is achieved, while warning that additional financing may be needed for acquisitions or unplanned costs.
- Dividends paid in 2013 totaled $35.4 million. The Q4 payment was $0.37 per share, including the regular dividend and a special capital-return payment. In February 2014, the board approved a $0.39-per-share Q1 2014 dividend. Future dividends and capital returns remain discretionary.
- No specific numerical revenue or earnings guidance is provided. Management expects continued Internet traffic growth and intends to expand sales, on-net buildings and network use, while acknowledging that declining prices may constrain revenue growth and profitability.
Risks, contingencies and unusual items
- In 2013, major U.S. telephone and cable companies began refusing to upgrade certain settlement-free peering connections. Cogent warned that congestion or disputes could degrade service, harm customer retention and increase costs.
- The network depends on third-party dark-fiber providers and local carriers for off-net connections, and relies heavily on Cisco for network equipment. Service interruptions, vendor issues, cyberattacks and damage to key network facilities could disrupt operations.
- Competition and falling per-megabit prices, customer retention and growth, foreign exchange movements, overseas operating losses, and potential regulatory or tax changes are material risks. Certain U.S. net operating losses are subject to Section 382 limitations.
- Management disclosed potential losses of up to $1.9 million above amounts accrued for disputed leased-circuit and dark-fiber costs. A former-sales-employee collective action alleging wage-and-hour violations remained pending; the company disputes the claims. Management did not expect other proceedings to materially affect results.
- Cogent reported effective disclosure controls and internal control over financial reporting; Ernst & Young issued unqualified audit opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether the $49.7 million tax benefit and deferred-tax-asset realization assumptions are sustainable, and how limited NOLs affect future cash taxes.
- How the June 2014 convertible-note put was addressed after the filing date, and the company’s subsequent debt, cash and liquidity position.
- Whether peering capacity disputes were resolved and whether traffic growth is translating into reliable service and profitable revenue.
- Whether connection growth can offset continuing price and ARPU declines, particularly for net-centric customers.
- Whether planned dividends and capital returns remain supported by operating cash flow, capital spending and debt obligations.