Business context and reporting period
Cogent Communications Group, Inc. (the filing registrant) is a facilities-based provider of Internet access and IP communications services to business, communications-service-provider and bandwidth-intensive customers in North America and Europe. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2011; comparisons are with the corresponding 2010 periods. Amounts below are in millions except per-share data and where noted.
Financial performance and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Service revenue | $77.4 | $66.8 | $226.4 | $194.0 |
| Operating income | $9.6 | $3.7 | $25.6 | $9.4 |
| Operating margin | 12.4% | 5.6% | 11.3% | 4.9% |
| Net income (loss) | $0.3 | $(0.5) | $2.1 | $(1.9) |
| Interest expense | $9.0 | $4.1 | $25.7 | $12.3 |
| Operating cash flow | Not separately presented for quarter | $48.5 | $49.5 | |
| Capital expenditures | Not separately presented for quarter | $35.4 | $41.0 |
Q3 revenue rose 15.8%; nine-month revenue rose 16.7%. Operating income improved substantially in both comparisons, while higher interest expense partly offset the improvement. Q3 and nine-month 2011 diluted EPS were $0.01 and $0.05, respectively, versus losses of $0.01 and $0.04 in 2010. The filing does not present gross profit or gross margin as a separate measure.
At September 30, 2011, cash and cash equivalents were $224.1, versus $56.3 at December 31, 2010; current assets were $258.7 and current liabilities $39.1. Total assets were $578.1, total liabilities $419.5 and stockholders’ equity $158.6. Total indebtedness, net of discount, was $384.2, including $134.0 of capital lease obligations; cash therefore exceeded this reported debt measure by $160.1. The company reported $175.0 of senior secured notes and $75.2 carrying value of convertible notes.
Material changes and management commentary
- On-net revenue increased 13.9% in Q3 and 14.6% for the nine-month period; off-net revenue increased 23.8% and 26.1%, respectively. On-net connections grew 23.5% year over year, faster than on-net revenue, as average revenue per connection declined amid customer-mix changes and volume- and term-based discounts. Off-net revenue growth reflected more connections and higher average revenue per connection.
- Network operating costs rose with network and facilities expansion and off-net service growth; SG&A increased as the company expanded sales and marketing. Management cited continued Internet-access price erosion as a potential restraint on revenue growth and profitability.
- Operating cash flow was slightly lower year over year despite higher operating profit; management attributed the decline partly to operating asset and liability movements and the $8.1 cash interest payment on the senior notes. Investing cash use declined as property and equipment purchases fell.
- The company issued $175.0 of 8.375% senior secured notes in January 2011, receiving $170.5 net proceeds. The notes mature in 2018 and are secured by substantially all company and guarantor assets, subject to the indenture. Nine-month interest expense also includes increased capital-lease costs.
- The company reported a $2.7 gain in the first half of 2011 after being released from an IRU capital-lease obligation; the related asset had been fully impaired in 2008. No property-and-equipment impairment was recorded in the first nine months of 2011, compared with $0.6 in 2010.
Outlook, risks and contingencies
No numerical revenue, earnings or cash-flow guidance is provided. Management said cash on hand and operating cash generation should meet working-capital, capital-expenditure, debt-service and other requirements if the business plan is executed. It cautioned that acquisitions or other significant unplanned needs could require additional financing, which may not be available on acceptable terms; insufficient funds could force slower network expansion or reduced sales and marketing investment.
Risks identified include economic weakness, foreign-exchange movements, competition and price declines, customer and traffic growth, peering arrangements, reliance on Cisco equipment and third-party fiber, network disruptions, regulation and litigation. Management expects non-core service revenue to continue declining. Routine legal matters were not expected to materially affect results; management did not expect resolution of tax examinations to have a material impact in the next 12 months. A $50.0 share-repurchase authorization had $47.1 remaining at quarter-end; 229,556 shares had been repurchased for $2.9. The CEO and his wife own the partnership leasing the company’s headquarters; the lease was extended through August 2013.
Important facts for investors to verify
- Whether revenue growth and connection growth can continue despite lower average revenue per on-net connection and industry pricing pressure.
- Cash generation relative to capital investment, lease payments, and cash interest obligations.
- Debt terms, collateral and covenants for the 8.375% secured notes, and the implications of the company’s total debt and lease commitments.
- Use of the senior-note proceeds and remaining share-buyback authorization, including any repurchases, debt buybacks or dividends.
- Exposure to foreign exchange, key suppliers and fiber providers, customer concentration, network reliability, regulatory changes and litigation.