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CCOI > SEC Filings for CCOI > Form 10-Q on 8-May-2013All Recent SEC Filings

Show all filings for COGENT COMMUNICATIONS GROUP INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for COGENT COMMUNICATIONS GROUP INC


8-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

You should read the following discussion and analysis together with our condensed consolidated financial statements and related notes included in this report. The discussion in this report contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this report should be read as applying to all related forward-looking statements wherever they appear in this report. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to these differences include, but are not limited to:

Future economic instability in the global economy, which could affect spending on Internet services; the impact of changing foreign exchange rates (in particular the Euro to USD and Canadian dollar to USD exchange rates) on the translation of our non-USD denominated revenues, expenses, assets and liabilities; legal and operational difficulties in new markets; the imposition of a requirement that we contribute to the U. S. Universal Service Fund; changes in government policy and/or regulation, including rules regarding data protection and cyber security; increasing competition leading to lower prices for our services; our ability to attract new customers and to increase and maintain the volume of traffic on our network; the ability to maintain our Internet peering arrangements on favorable terms; our reliance on an equipment vendor, Cisco


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Systems Inc., and the potential for hardware or software problems associated with such equipment; the dependence of our network on the quality and dependability of third-party fiber providers; our ability to retain certain customers that comprise a significant portion of our revenue base; the management of network failures and/or disruptions; and outcomes in litigation as well as other risks discussed from time to time in our filings with the Securities and Exchange Commission, including, without limitation, our annual report on Form 10-K for the fiscal year ended December 31, 2012.

General Overview

We are a leading facilities-based provider of low-cost, high-speed Internet access and IP communications services. Our network is specifically designed and optimized to transmit data using IP. We deliver our services to small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations in North America and Europe and more recently in Japan.

Our on-net service consists of high-speed Internet access and IP connectivity ranging from 100 Megabits per second to 10 Gigabits per second of bandwidth. We offer our on-net services to customers located in buildings that are physically connected to our network. We provide on-net Internet access to net-centric and corporate customers. Our net-centric customers include bandwidth-intensive users such as universities, other Internet service providers, telephone companies, cable television companies, web hosting companies, content delivery networks and commercial content and application providers. These customers generally receive our service in colocation facilities and in our data centers. Our corporate customers are located in multi-tenant office buildings and typically include law firms, financial services firms, advertising and marketing firms and other professional services businesses.

Our off-net services are sold to businesses that are connected to our network primarily by means of "last mile" access service lines obtained from other carriers, primarily in the form of point-to-point, Carrier Ethernet, TDM, POS, and/or SDH circuits. Our non-core services, which consist primarily of legacy services of companies whose assets or businesses we have acquired, primarily include voice services (only provided in Toronto, Canada). We do not actively market these non-core services and expect the service revenue associated with them to continue to decline.

Our network is comprised of in-building riser facilities, metropolitan optical fiber networks, metropolitan traffic aggregation points and inter-city transport facilities. Our network is physically connected entirely through our facilities to 1,890 buildings in which we provide our on-net services, including over 1,310 multi-tenant office buildings. We also provide on-net services in carrier-neutral colocation facilities, Cogent controlled data centers and single-tenant office buildings. Because of our integrated network architecture, we are not dependent on local telephone companies to serve our on-net customers. We emphasize the sale of our on-net services because we believe we have a competitive advantage in providing these services and these services generate gross profit margins that are greater than the gross profit margins on our off-net services.

We believe our key growth opportunity is provided by our high-capacity network, which provides us with the ability to add a significant number of customers to our network with minimal direct incremental costs. Our focus is to add customers to our network in a way that maximizes its use and at the same time provides us with a profitable customer mix. We are responding to this opportunity by increasing our sales and marketing efforts including increasing our number of sales representatives and expanding our network to locations that we believe can be economically integrated and represent significant concentrations of Internet traffic. One of our keys to developing a profitable business will be to carefully match the cost of extending our network to reach new customers with the revenue expected to be generated by those customers. In addition, we may add customers to our network through strategic acquisitions.

We believe some of the most important trends in our industry are the continued long-term growth in Internet traffic and a decline in Internet access prices on a per megabit basis. The effective price per megabit for our corporate customers is declining as the bandwidth utilization and connection size of our corporate customer connections increases. As Internet traffic continues to grow and prices per unit of traffic continue to decline, we believe we can continue to load our network and gain market share from less efficient network operators. However, continued erosion in Internet access prices will likely have a negative impact on the rate at which we can increase our revenues and our profitability. Our revenue may also be negatively affected if we are unable to grow our Internet traffic or if the rate of growth of Internet traffic does not offset the expected decline in per unit pricing. We do not know if Internet traffic will increase or decrease, or the rate at which it will grow or decrease. Changes in Internet traffic will be a function of the number of users, the applications for which the Internet is used, the bandwidth intensity of these applications and the pricing of Internet services, and other factors.

The growth in Internet traffic has a more significant impact on our net-centric customers who represent the majority of the traffic on our network and who tend to consume the majority of their allocated bandwidth on their connections. Net-centric customers tend to purchase their service on a price per megabit basis. Our corporate customers tend to utilize a small portion of their allocated bandwidth on their connections and tend to purchase their service on a per connection basis.

We are a facilities-based provider of Internet access and communications services. Facilities-based providers require significant physical assets, or network facilities, to provide their services. Typically when a facilities-based network services provider begins providing its services in a new jurisdiction losses are incurred for several years until economies of scale have been achieved. Our foreign operations are in Europe, Canada, Mexico and Japan. Europe accounts for roughly 75% of our foreign operations. Our European operations have incurred losses and will continue to do so until the European customer base and revenues have grown sufficiently to achieve economies of scale.

Due to our strategic acquisitions of network assets and equipment, we believe we are well positioned to grow our revenue base. We continue to purchase and deploy network equipment to parts of our network to maximize the utilization of our assets and to expand and increase the


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capacity of our network. Our future capital expenditures will be based primarily on the expansion of our network, the addition of on-net buildings and the concentration and growth of our customer base. We plan to continue to expand our network and to increase the number of on-net buildings we serve including multi-tenant office buildings and carrier neutral data centers. Many factors can affect our ability to add buildings to our network. These factors include the willingness of building owners to grant us access rights, the availability of optical fiber networks to serve those buildings, and equipment availability.

Three Months Ended March 31, 2013 Compared to the Three Months Ended March 31, 2012

The following summary table presents a comparison of our results of operations for the three months ended March 31, 2013 and 2012 with respect to certain key financial measures. The comparisons illustrated in the table are discussed in greater detail below.

                                                      Three months ended
                                                          March 31,          Percent
                                                       2013         2012     Change
                                                        (in thousands)
Service revenue                                     $    84,553   $ 76,888      10.0 %
On-net revenue                                           61,678     56,750       8.7 %
Off-net revenue                                          22,309     19,501      14.4 %
Non-core revenue                                            566        637     (11.1 )%
Network operations expenses (1)                          37,309     34,338       8.7 %
Selling, general, and administrative expenses (2)        21,465     21,343       0.6 %
Depreciation and amortization expenses                   15,874     15,239       4.2 %
Interest expense                                          9,869      8,993       9.7 %
Income tax (expense) benefit                               (333 )      560    (159.5 )%



(1) Includes equity-based compensation expenses of $155 and $83 in the three months ended March 31, 2013 and 2012, respectively, which, if excluded would have resulted in a period-to-period change of 8.5%.

(2) Includes equity-based compensation expenses of $2,359 and $1,155 in the three months ended March 31, 2013 and 2012, respectively, which, if excluded would have resulted in a period-to-period change of (5.4)%.

Service Revenue. Our service revenue increased 10.0% to $84.6 million for the three months ended March 31, 2013 from $76.9 million for the three months ended March 31, 2012. The impact of exchange rates resulted in an increase of revenues for the three months ended March 31, 2013 of approximately $0.1 million. All foreign currency comparisons herein reflect our first quarter 2013 results translated at the average foreign currency exchange rates for the first quarter of 2012. For the three months ended March 31, 2013 and 2012, on-net, off-net and non-core revenues represented 72.9%, 26.4% and 0.7% and 73.8%, 25.4% and 0.8% of our service revenue, respectively. In January 2012, one of our customers (on-net and net-centric) was indicted by the U.S. government and as a result our on-net service to this customer and the associated revenue terminated in January 2012. This customer accounted for approximately 1.1% of our first quarter 2012 revenues. The loss of this net-centric customer negatively impacted our revenue growth rate from the first quarter of 2012 to the first quarter of 2013.

Revenues from our corporate and net centric customers represented 50.8% and 49.2% of total service revenue, respectively, for the three months ended March 31, 2013 and represented 50.8% and 49.2% of total service revenue, respectively, for the three months ended March 31, 2012. Revenues from corporate customers increased 10.0% to $43.0 million for the three months ended March 31, 2013 from $39.1 million for the three months ended March 31, 2012. Revenues from our net-centric customers increased 10.0% to $41.6 million for the three months ended March 31, 2013 from $37.8 million for the three months ended March 31, 2012. As noted above, the loss of a net-centric customer in January 2012 negatively impacted our net-centric revenue growth rate from the first quarter of 2012 to the first quarter of 2013.

Our on-net revenues increased 8.7% to $61.7 million for the three months ended March 31, 2013 from $56.8 million for the three months ended March 31, 2012. We increased the number of our on-net customer connections by 17.8% to approximately 30,900 at March 31, 2013 from approximately 26,200 at March 31, 2012. The loss of an on-net customer in January 2012 negatively impacted our on-net revenue growth rate from the first quarter of 2012 to the first quarter of 2013. On-net customer connections increased at a greater rate than on-net revenues due to a decline in the average revenue per on-net customer connection, primarily from our net centric customers. This decline is partly attributed to volume and term based pricing discounts. On-net customers who cancel their service from our installed base of customers, in general, have greater average revenue per connection than new customers. These trends resulted in a reduction to our average revenue per on-net connection.

Our off-net revenues increased 14.4% to $22.3 million for the three months ended March 31, 2013 from $19.5 million for the three months ended March 31, 2012. Our off-net revenues increased as we increased the number of our off-net customer connections by 15.9% to approximately 4,600 at March 31, 2013 from approximately 3,960 at March 31, 2012.

Our non-core revenues decreased 11.1% to $0.6 million for the three months ended March 31, 2013 from $0.6 million for the three months ended March 31, 2012. The number of our non-core customer connections decreased 15.7% to approximately 460 at March 31, 2013 from approximately 550 at March 31, 2012. We do not actively market these acquired non-core services and expect that the service revenue associated with them will continue to decline.


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Network Operations Expenses. Network operations expenses include the costs of personnel associated with service delivery, network management, customer support, network facilities costs, fiber and equipment maintenance fees, leased circuit costs, and access and facilities fees paid to building owners. Non-cash equity-based compensation expense is included in network operations expenses consistent with the classification of the employee's salary and other compensation. Our network operations expenses, including non-cash equity-based compensation expense, increased 8.7% to $37.3 million for the three months ended March 31, 2013 from $34.3 million for the three months ended March 31, 2012. The increase is primarily attributable to an increase in costs related to our network and facilities expansion activities and the increase in our off-net revenues. When we provide off-net services we also assume the cost of the associated tail-circuits. The impact of exchange rates resulted in an increase of network operations expenses for the three months ended March 31, 2013 of approximately $0.1 million.

Selling, General, and Administrative ("SG&A") Expenses. Our SG&A expenses, including non-cash equity-based compensation expense, increased 0.6% to $21.5 million for the three months ended March 31, 2013 from $21.3 million for the three months ended March 31, 2012. Non-cash equity-based compensation expense is included in SG&A expenses consistent with the classification of the employee's salary and other compensation and was $2.4 million for the three months ended March 31, 2013 and $1.2 million for the three months ended March 31, 2012. SG&A expenses increased primarily from an increase in non-cash equity-based compensation expense partly offset by a decrease in bad debt expense of approximately $1.6 million. Bad debt expense for the three months ended March 31, 2012 included amounts related to the loss of our largest customer in January 2012. The impact of exchange rates did not have a material impact on our SG&A expenses for the three months ended March 31, 2013.

Depreciation and Amortization Expenses. Our depreciation and amortization expense increased 4.2% to $15.9 million for the three months ended March 31, 2013 from $15.2 million for the three months ended March 31, 2012. The increase is primarily due to the depreciation expense associated with the increase in deployed fixed assets. The impact of exchange rates did not have a material impact on our depreciation and amortization expenses for the three months ended March 31, 2013.

Interest Expense. Interest expense results from interest incurred on our $175.0 million of 8.375% Senior Secured Notes (the "Senior Notes") issued on January 26, 2011, our $92.0 million of 1.00% convertible senior notes (the "Convertible Notes") issued in June 2007, and interest on our capital lease obligations. Our interest expense increased 9.7% to $9.9 million for the three months ended March 31, 2013 from $9.0 million for the three months ended March 31, 2012. The increase is attributed to interest expense related to an increase in our capital lease obligations and from an increase in the amortization of the debt discount on our Convertible Notes. The impact of exchange rates did not have a material impact on our interest expense for the three months ended March 31, 2013.

Income Tax (Expense) Benefit. Our income tax expense was $0.3 million for the three months ended March 31, 2013 and our income tax benefit was $0.6 million for the three months ended March 31, 2012. The income tax expense for the three months ended March 31, 2013 includes approximately $0.2 million for Canadian and other foreign income taxes and $0.1 million for state income taxes. The income tax benefit for the three months ended March 31, 2012 includes income tax expense of $0.2 million for Canadian and other foreign income taxes offset by a $0.8 million income tax benefit for state income taxes.

Buildings On-net. As of March 31, 2013 and 2012, we had a total of 1,890 and 1,769 on-net buildings connected to our network, respectively.

Liquidity and Capital Resources

In assessing our liquidity, management reviews and analyzes our current cash balances, accounts receivable, accounts payable, accrued liabilities, capital expenditure commitments, and required capital lease and debt payments and other obligations.

Cash Flows



The following table sets forth our consolidated cash flows for the three months
ended March 31, 2013 and three months ended March 31, 2012.



                                                               Three months ended March 31,
(in thousands)                                                    2013               2012
Net cash provided by operating activities                   $         14,962    $       12,686
Net cash used in investing activities                                (16,314 )         (12,178 )
Net cash used in financing activities                                (10,238 )          (6,962 )
Effect of exchange rates on cash                                        (735 )             541
Net decrease in cash and cash equivalents during period     $        (12,325 )  $       (5,913 )

Net Cash Provided by Operating Activities. Our primary sources of operating cash are receipts from our customers who are billed on a monthly basis for our services. Our primary uses of operating cash are payments made to our vendors, employees and interest payments made to our capital lease vendors and our note holders. Net cash provided by operating activities was $15.0 million for the three months ended March 31, 2013 compared to net cash provided by operating activities of $12.7 million for the three months ended March 31, 2012. The change in cash provided by operating activities is primarily due to an increase in our operating income.


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Net Cash Used In Investing Activities. Net cash used in investing activities was $16.3 million for the three months ended March 31, 2013 and $12.2 million for the three months ended March 31, 2012. Our primary use of investing cash is for purchases of property and equipment. Purchases of property and equipment were $16.3 million and $12.3 million for the three months ended March 31, 2013 and 2012, respectively. The changes in purchases of property and equipment are primarily due to the timing and scope of our network expansion activities including geographic expansion and adding buildings to our network.

Net Cash Used In Financing Activities. Net cash used in financing activities was $10.2 million for the three months ended March 31, 2013 and $7.0 million for the three months ended March 31, 2012. Our primary use of financing cash is for principal payments under our capital lease obligations and dividend payments made to our shareholders. Principal payments under our capital lease were $5.0 million and $7.1 million for the three months ended March 31, 2013 and 2012, respectively. We began paying a quarterly dividend on our common stock in the third quarter of 2012. During the three months ended March 31, 2013 we paid $5.5 million for our first quarter 2013 dividend payment.

Cash Position and Indebtedness

Our total indebtedness, net of discount, at March 31, 2013 was $408.9 million and our total cash and cash equivalents were $235.0 million. Our total indebtedness at March 31, 2013 includes $149.9 million of capital lease obligations for dark fiber primarily under long term IRU agreements.


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Common Stock Buyback Program

Our board of directors has approved $50.0 million of purchases of the Company's common stock under a buyback program (the "Buyback Program"). There is approximately $45.8 million remaining for purchases under the Buyback Program. There were no purchases made during the three months ended March 31, 2013 and 2012.

Dividends on Common Stock

Dividends are recorded as a reduction to retained deficit. Dividends on unvested restricted shares of common stock are paid as the awards vest. On February 20, 2013, our board of directors approved the payment of a dividend of $0.12 per common share to holders of record on March 4, 2013. The $5.5 million dividend payment was made on March 15, 2013. On April 18, 2013, our board of directors approved the payment of a dividend of $0.13 per common share to holders of record on May 31, 2013. The estimated $6.1 million dividend payment will be made on June 18, 2013.

The payment of any future dividends will be at the discretion of the Company's board of directors and will be dependent upon the Company's financial position, results of operations, available cash, cash flow, capital requirements and other factors deemed relevant by the Company's board of directors.

Contractual Obligations and Commitments

There have been no material changes to our contractual obligations and commitments included in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our annual report on Form 10-K for the year ended December 31, 2012.

Future Capital Requirements

We believe that our cash on hand and cash generated from our operating activities will be adequate to meet our working capital, capital expenditure, debt service, dividend payments and other cash requirements if we execute our business plan.

Any future acquisitions or other significant unplanned costs or cash requirements in excess of amounts we currently hold may require that we raise additional funds through the issuance of debt or equity. We cannot assure you that such financing will be available on terms acceptable to us or our stockholders, or at all. Insufficient funds may require us to delay or scale back the number of buildings and markets that we add to our network, reduce our planned increase in our sales and marketing efforts, or require us to otherwise alter our business plan or take other actions that could have a material adverse effect on our business, results of operations and financial condition. If issuing equity securities raises additional funds, substantial dilution to existing stockholders may result.


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Off-Balance Sheet Arrangements

We do not have relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Critical Accounting Policies and Significant Estimates

Management believes that as of March 31, 2013, there have been no material changes to our critical accounting policies and significant estimates from those listed in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our annual report on Form 10-K for the year ended December 31, 2012.

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