Business context and reporting period
Cogent Communications Group, Inc. and subsidiaries filed this unaudited Form 10-Q for the quarter ended June 30, 2013. The company provides IP connectivity and Internet access over its own network, serving business and bandwidth-intensive customers in North America and Europe, with recent expansion into Japan.
Financial performance and position
Amounts are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
| Metric | Q2 2013 | Q2 2012 | Change |
|---|---|---|---|
| Service revenue | $85.8 | $77.8 | +10.3% |
| Operating income | $11.6 | $7.8 | +48.7% |
| Operating margin | 13.5% | 10.0% | +3.5 percentage points |
| Net income (loss) | $1.6 | $(1.8) | Turned profitable |
| Net margin | 1.9% | (2.3)% | Improved |
| Interest expense | $10.2 | $9.0 | +13.7% |
For the six months ended June 30, revenue was $170.4 million, up 10.1%; operating income was $21.5 million versus $13.8 million; and net income was $2.0 million versus a net loss of $3.9 million. Six-month operating cash flow was $37.7 million, compared with $32.2 million. Property and equipment purchases were $28.8 million, versus $22.9 million; operating cash flow less those purchases was approximately $8.9 million, versus $9.3 million.
Cash and cash equivalents were $237.3 million at June 30, 2013, down from $247.3 million at year-end 2012. Total indebtedness, net of discount, was $412.5 million, including $151.9 million of capital lease obligations; the company reported $175.0 million of senior secured notes and $92.0 million principal of convertible notes. The convertible notes’ $85.6 million net carrying amount was classified as current because their earliest put date is June 2014. Current assets were $278.9 million and current liabilities $136.2 million.
Material changes and operating trends
- Q2 on-net revenue rose 9.4% to $62.7 million and off-net revenue rose 13.8% to $22.6 million; non-core revenue declined 19.4% to $0.5 million. Corporate and net-centric customer revenue increased 10.7% and 9.8%, respectively.
- On-net connections increased 16.0% year over year to approximately 31,900, while on-net revenue grew more slowly; management attributed this to declining average revenue per connection, including volume- and term-based discounts. Off-net connections rose 15.3% to approximately 4,700. Connected buildings increased to 1,921 from 1,799.
- Q2 network operations expense increased 5.6% and SG&A increased 9.4%, reflecting network expansion and sales-related costs. Six-month SG&A growth was 4.6%, partly offset by lower bad-debt expense than in 2012, which included charges related to the loss of the largest customer.
- Capital lease obligations increased from $137.9 million at year-end to $151.9 million; the company incurred $21.2 million of capital lease obligations in the first half. The balance-sheet reclassification of convertible notes to current also contributed to the increase in current liabilities.
Outlook, risks and unusual items
No quantified revenue or earnings guidance is provided. Management said cash on hand and operating cash generation should meet working-capital, capital expenditure, debt-service, dividend and other requirements if the business plan is executed. Expansion spending will depend on network growth and building additions; management noted that insufficient financing could require scaling back expansion or sales efforts.
Beginning in Q3 2013, the board planned an additional $10 million quarterly return of capital through buybacks, a special dividend, or both, in addition to regular dividends, until adjusted net debt to trailing-twelve-month EBITDA reaches 2.5:1. A $0.14-per-share dividend was approved for September 2013. Future distributions remain subject to board discretion and the company’s financial position.
Risks cited include competition and pricing pressure, customer and traffic growth, peering terms, reliance on Cisco equipment and third-party fiber, network disruptions, foreign-exchange movements, regulation, and challenges in new markets. Management said European operations continued to incur losses pending sufficient scale. Potential litigation includes employee classification and wage claims; the company disputes the claims. It also disclosed up to $1.7 million of possible loss beyond the amount accrued for certain leased-circuit and dark-fiber obligations. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether customer and traffic growth can offset declining average revenue per on-net connection and per-unit pricing.
- Capital spending, lease commitments, and the company’s ability to sustain cash generation while funding network expansion and shareholder returns.
- The June 2014 earliest put date for the convertible notes and the company’s plans for addressing that obligation.
- Execution and duration of the additional quarterly $10 million capital-return program and the leverage measure governing its end.
- Potential exposure from litigation and leased-circuit or dark-fiber disputes, as well as the pace toward scale in Europe and newer markets.